It’s painfully obvious from
consumer sentiment data and market statistics that a new normal is coming into focus which has the effect of
recalibrating everything financial, from earnings patterns to capital gains
expectations. Curious that back in the
late 1990’s our dot.com brethren spoke of a New Paradigm. I don’t think this is the schematic they
envisioned, though.
As a result, I have to prepare
both my clients and their portfolios for a new calibration of return on
equity. It stands to reason that as
earnings acceleration patterns diminish, so too does the prospect for equity
price appreciation. Higher volatility, shorter amplitudes for price cycles, and declining
sector allocations are likely to be our basis for the next few decades.
Method shift.
What should we do to prepare
for, and hopefully profit from, these new dynamics? For
one, we must recognize that active, customized portfolio management always
trumps static, non-managed accounts. High cost mutual funds have always been suspect
for generating returns, in part because of their size, but also because they
lose the flexibility of maneuvering within cycles. Today, the markets have taken on a trading
configuration which, unfortunately, dictates a shorter time-line even within a
longer term arc of secular demographics.
Beta is increasing as alpha is diminishing.
Secondly, it is more important than ever before to
define the secular themes, map out a topography, and remain consistent in one’s
exposure to highly successful market cycles. In the broadest sense,
methodology and process are more important than return.
We need to keep in mind that
investing is a journey, a process itself, which means ups and downs, detours,
and sometimes some stress. To achieve a
“guaranteed” return means you are not investing, you are simply giving up or
giving in.
Analysis shifts, too.
The most important function I
provide to my clients is the mitigation of downside risk through the use of
quantitative tools that measure cycle persistence, magnitude, and
probability. As my accounts have demonstrated,
we have had remarkably low drawdown even during periods of severe financial
rupture. This has allowed us to
outperform most benchmarks and to avoid the pitfall of hitting home runs to
recoup severe losses. In a low-to-static
growth market these asset allocation cycles will play an even more important
role in managing both return and client expectations.
We must also recognize that
assets are becoming less correlated,
not more. Despite the fact that it appears as if everything is going down in
value, the pockets of non-correlated phenomena are becoming more diverse. The challenge, then, is to find those pockets
and to capitalize upon them without shifting into intolerable asset allocation
patterns.
The new normal is still consistent with prudent portfolio management
theory. There is really not a lot that
is “new.” Quality securities in the
right risk tolerance profile should always be our objective. While the baseline is being recalibrated
based upon today’s current events, we want our actions to be consistently
justified and standardized for the long haul.
Accept that history is still on our side, and patience is also a
portfolio tool.
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