There is one certainty about
today’s financial markets: nothing is
certain. Traversing the economic
landscape is akin to walking across a room with a trap door looming unseen.
It is not just equities which
pose this risk. Austerity programs
worldwide are forcing interest rates down, and bid prices to fall as well. In effect, waiting until maturity is one’s
greatest hope for financial recapture in a bond portfolio. As
strongly as capital gains drove bond investing during a period of declining
rates, strategic options don’t exist anymore as long as interest rates remain
pegged to these low levels.
It’s an interesting
juxtaposition. As stock prices fall, so
too do bond prices, losing the “alternative
investment scenario” portfolio managers have come to rely upon for risk
diversification.
The reasons for this are many,
not the least of which is a deterioration of fundamentals and psychology
(conviction) about investing in the first place. Natural resources, industrial production,
hiring, and debt levels are trends with negative
direction. An increasing focus upon the
lack of conviction has drawn an imaginary line between what is possible and
what is necessary to revitalize an economy stalled, or in reverse. Wild swings in valuation during the previous
two months confirm that volatility and inertia are going to sustain for awhile
longer.
As we look for alternatives,
our aperture must widen to include demographic themes which resonate counter
cyclically. That is, irrespective of the direction of stocks or bonds, we must find
those things which need to be done and hope to make capital gains probabilities
from them.
I’ve had some clients ask me
why we “lost” some money from portfolio valuation during the previous
quarter. It’s a question that is not so
much seeking a market hypothesis or written text. Rather, it speaks to portfolio methodology,
in which case our “losses” were less than the benchmarks because we don’t use
the benchmarks as our axis.
Instead, through asset
allocation and risk diversification amongst sectors, we didn’t “lose” anything,
we simply followed, to a lesser degree, the ebb and flow of the broader
financial markets.
Investing is not static. One’s
high water mark in April is not the apex of valuation, nor is October the
nadir. The trend is significant, and my clients know that we have outperformed
the trend by a significant amount over time because we know how to avoid risk,
and to balance asset allocation probabilities.
It is vital not to throw all
one’s eggs in one basket. If you owned
only gold, or timber, or IBM, your fortunes vacillated from undue
risk-taking. Growth prospects heighten
when a portfolio is structurally diversified.
As downtrends continue to widen, by asset class and sector, bottoms look
more tenuous and likely to “break.”
Weeks of downside uncertainty and market volatility heighten the
probability that the trap door might drop into a hard fall.
Such is not what I wish for,
but get nervous about nonetheless.
Temporarily, I will focus on
correlating asset balance to risk parameters, avoiding the possibility of
seismic underperformance or dislocation.
If that means shortening investment durations, my hope would be to yield
positive alpha during manic upside feeding frenzies.
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