As seen in Paragon’s 1 Quarter 2009 Print Newsletter
Written by Dave Young, President of Paragon Wealth Management
photo by nicknbecka
In stark contrast to his popularity with the general public, a recent Wall Street Journal poll of top Economists gave the president an “F” grade for his performance so far. Every day Obama introduces a new program, makes an appearance on television, and there is news from Washington that affect the markets.
According to the metrics we follow, the selloff in October should have marked the bottom of this bear market.
I believe this bear market would have ended last October if it weren’t for the perpetual bad news from Washington.
· After the election the market sold off hard and hit new lows on November 20because of investor fears surrounding a new administration.
· As rumors swirled that Obama would govern from the center and not the left, the market rallied up until the first week of January. Hopes were high that the Obama administration would quickly provide a comprehensive solution.
· The market dropped 4% on inauguration day, which is the most it has ever dropped.
· Obama appeared on TV every day and repeatedly used words such as crisis, catastrophe and Great Depression. Traders began to sell the market short during each TV appearance.
· On February 10, the new Treasury Secretary gave a highly anticipated speech about the administration’s new plan to save the banks. The speech was not what the market hoped for or expected, and once again the market sold down to new lows.
· Next, the White House and Congress worked together to jam a $787 billion “stimulus” package (the largest ever) through Congress in four days. Investors were initially optimistic about a stimulus package until they realized it was comprised of one third legitimate stimulus and two thirds social programs. This caused investors to sell stocks again.
· The stimulus bill was followed by a $410 billion omnibus spending bill.
· That was followed by a gigantic proposed budget that will double the national deficit in five years and triple it in 10.
In summary, Obama’s enormous spending plans, proposed tax increases, and lack of focus on the economy caused the market to drop 25% from January 1 to March 9.
WHY BE OPTIMISTIC?
Once you hit a certain point you run out of sellers and there is nothing left to bring the market further down. It appears we may have hit that low point on March 9.
The market was down 54% from its peak at that point, and it appeared as though everything negative had been factored in, maybe several times over. With confidence completely destroyed high yield bond portfolios default rates are projected at double what they were during the Great Depression. Another metric shows consumer spending at the same level it would be if unemployment were 30%. (It’s actually 8.5%)
Looking forward, not backward, things actually look pretty good.
Imagine you were asleep the past 18 months and just woke up. This is what you would find:
· Six of our eight “bull watch” indicators support the case for a new bull market.
· Six of the 10 leading economic indicators were up in February.
· Housing is more affordable and mortgage rates are lower than they have been for some time.
· Energy is more affordable for consumers and businesses.
· Credit is loosening, and interest rates are extremely low.
· There will be massive global government stimulus forthcoming.
· Abundant amounts of investor cash is on the sidelines.
· This has been called “the sale of the century.” In inflation-adjusted terms, the Dow Industrials it is at that same level it was 43 years ago. In 1966 we didn’t have PCs, Internet and our work force was half the size of what it is today.
· Four fifths of top economists in the latest Wall Street Journal survey said now is a good time to buy stocks.
· Investor sentiment has reached negative extremes and started to reverse.
We are holding a significant amount of cash equivalents in our conservative portfolios, and are waiting for tape confirmation that this market has turned before we are fully invested. We are fully invested in our growth portfolios in the areas of the market that have historically performed the best after a bear market. After the 2000-2002 bear market we were close to doubling the return of the market averages by positioning our portfolios in the best places.
As I’ve mentioned before, this is the 34th bear market in the past 100 years. The future always looks bleak when the bear market is the worst, and people become irrationally pessimistic.
That is when the naysayers have their day of fame. The media loves to cover them. They always expect things to get worse, and attract a lot of followers.
They have been wrong every time. Not wrong once or twice, but the past 34 times.
Our economic system is very resilient. Our markets and economy have always recovered from difficult times in the past. We’ve made it through recessions, world wars, a civil war and a depression. I believe in the free market system.
Our market and economy will recover again, in spite of our politicians.
As seen in Paragon’s 1 Quarter 2009 Print Newsletter
Written by Dave Young, President of Paragon Wealth Management
photo by D-32
The drama in the stock market continued during the first quarter of 2009. Even though the quarter was negative, it ended on a positive note. For the month of March, the S&P 500 gained 8.9%. The NASDAQ had its best March with an 11% gain.
The 2008 bear market was caused by the credit crisis with additional negative input from politics and the media.
On the other hand, the continuation of the decline into 2009 was primarily caused by politics. Uncertainty soared, and the new faces in Washington scared investors when they announced new government programs daily. When investors are scared, their confidence is destroyed, and they sell.
The Dow Jones Industrial Average lost -8.8% in January and then an additional
-11.7% in February. By March 9, the Dow lost another -7.7% and hit a 12 1/2 year low landing at an unbelievable level of 6516. This put the Dow Industrials back at the same level it was in November 1996.
With almost 13 years of gains wiped out, and the Dow industrials down 54% from its high, the market began to rally. From the lows on March 9 until the end of the month, the Dow rallied almost 1100 points to 7600. From the low point, the market rallied almost 17% by the end of the month. That rally was the fastest and steepest one since 1938.
Where does this leave us?
The Dow Industrials hit 7552 on November 20 of last year. As of March 31, 2009 the market closed at 7608, up slightly from the November 2008 level. Even though it feels like the market only goes down, it is actually back to where it was four months ago.
While no one knows for certain where the market will go next, we can compare this market’s path to previous bear markets. First, in October we saw a waterfall style decline as the market hit a low as the result of panic selling. In November the market hit a lower low, but on less volume. After backing and filling for a couple months, it hit another low in March, again on less volume. The initial October low was the result of massive amounts of selling. The next two lows were the result of lack of buyers.
While there are no guarantees that this is the bottom, this pattern of lower lows on less volume has often marked a bottom in previous bear markets.
To be continued… The Stock Market Drama Continues…Part 2
As seen in Paragon’s 1 Quarter 2009 Print Newsletter
Written by Nathan White, Chief Investment Officer
As a follow up to our recent webinars, I would like to review our thoughts about our current positioning and outlook.
SIGNS OF RECOVERY
Along with the recent March rally, we see encouraging signs of improved market performance. This supports the likelihood that the market is near the end of the bottoming process, which started in October when the market fell off a cliff. At these depressed levels, so much bad news has been priced into the markets that the downside risks have been significantly reduced. To be sure, downside risks still remain because there is still much uncertainty in the air.
The stock market is crowd psychology in action, and confidence is an important ingredient for improvement. The government and the media are two of the main influences on investor and consumer confidence for better and worse. After some initial bungling and naive actions by the Obama administration, which served as the catalyst for much of the downturn, it is interesting to hear them change their tune from talking the economy down to talking it up.
Although Obama’s true aspirations revolve around, as Charles Krauthammer said in his most recent column, the holy trinity of health care, education and energy in order to bring about a leveled and social democratic society, Obama has no choice but to focus on the economy first. He cannot move on to his real agenda without first getting the economy back on its feet in some form. Now that the administration has changed its tune, the main-stream media should follow suit.
During the waterfall decline in October/November and the slide in February, investor sentiment gauges hit extreme low levels. These low levels indicate that so many people are bearish and have already sold out of the market. Up turns off of extreme low levels on these indicators are positive signs, and this has been occurring through March. Most measures of consumer sentiment are also stabilizing. The Consumer Sentiment Index actually rose for March and was better than expected.
Market volatility has subsided from record historical levels. Volatility levels are a good measure of the amount of fear in the market and indicate how hard the market is trying to shake people out. Those who are able to hold on through the “shaking” are left holding the productive assets that others then inevitably bid up. The February slide in the markets was not as widespread and without the same momentum as the October/November drop with some areas such as Technology holding quite well on a relative basis.
Whether you agree with them or not, the aggressive government policy responses will benefit the economy in the short-term. These policy responses which include interest-rate cuts, quantitative easing actions, bailouts, and fiscal stimulus packages are occurring on a world-wide scale. Don’t underestimate the power of these actions in the short-term as they can have a profound effect. Yes, the government can easily be creating more potential long-term problems with these actions (i.e., inflation, expectations of being bailed out, higher taxes, unintended consequences, etc.), but as the credit mess starts to clear up, the rest of the economy is waiting to take off.
I believe the economy will turn positive on its own power regardless of the circus action in Washington. Businesses have significantly drawn down inventories and are running lean. Many will emerge from this downturn stronger than before. This will power a growth in earnings that will propel the market higher.
It is interesting to note that around the beginning of March many analysts and investment houses came out with their 2009 S&P 500 earnings forecasts. By applying a conservative multiple to the earnings, they were basically inferring that the S&P, which was just breaking below 700 at the time, was still overvalued and would continue to fall (e.g., Goldman Sachs came out with a forecast of $40/shr for the S&P 500). These forecasts are usually about as reliable as the weather on Mount Everest, and just as ill-timed.
CAUSES OF THE MARKET COLLAPSE
One of the main culprits of the market collapse is the market-to-market accounting standards that forced financial companies into a downward spiral by forcing them to value their assets at the last trade rather than by cash flows. In his recent Forbes column, Rich Karlgaard stated that 70% of the banks worst assets still generate cash. Assets should be valued based upon cash flows and losses realized when an actual impairment occurs. Market value is important, but only if you intend to sell the asset.
Another constructive regulatory relief would be to end the short uptick rule. I can’t figure out why this simple rule, which exacerbates downward movements, has not been suspended. It costs taxpayers nothing!
We are also beginning to see signs of a housing bottom. This is not to say that I think housing will move up, but instead, it will stop going down. Housing affordability has markedly improved due to lower prices and low mortgage rates, and the over-supply is working itself off.
Something to keep in mind is that the moves off of bear market lows can be quick and powerful often due to seller exhaustion and short covering of which the March rally was a prime example. At the end of February, there was so much cash on the sidelines. It represented 47% of the total market value! That is an astonishing figure! As confidence returns, you will see this money start to go back into the market. Interest on savings accounts and cash is next to nothing. With so much cash on the sidelines, who stands to “lose” the most? –those who are in cash and end up getting back into the market after it has recovered.
At Paragon, we are actively positioning into areas that move the best after a bear market bottom. These include asset classes such as small and mid cap, sectors including technology, consumer discretionary, industrials and emerging markets such as Brazil and China. As the days progress, we will be looking for pullbacks that have less downside participation, volume and momentum followed by rallies to secondary highs. It will still be a rocky ride as the market always is, but for the moment there is more risk to being outside of the market than in.
Apr 01 2009
Wall Street Transcript Interview with Dave Young, President of Paragon Wealth Management.
By Daniel Kelley
TWST: Can you start with an overview of Paragon Wealth Management and your investment philosophy there?
Mr. Young: I started and sold several successful businesses back in 1986. As a resultof the sale of those businesses I had a significant savings that I needed to invest. After a lot of research I wasn’t able to find a firm that would do much more than take a buy and hold – hope and pray approach to investing my money. I was unwilling to put my life savings at risk with that approach and decided to manage the money myself.
I started out 23 years ago using a fairly simple approach based on technical analysis. Over the years our pro-active management strategy has evolved into one that is primarily quantitative with technical and fundamental inputs. After years of managing money in the markets, I still believe that there are much better investment strategies than simple buy and hold.
TWST: Tell us a bit about the client base that you have, who are your typical clients?
Mr. Young: Most of our clients are individuals and families, but we also manage money for businesses and non-profits. The majority of our clients are business owners, retirees and medical professionals. We actively manage all types of traditional and retirement accounts.
TWST: What services do you offer to your clients?
Mr. Young: Our primary focus is money management. We offer several portfolio options, some which are strategic and others that are more tactical. We are entirely fee based and do not sell any financial products or receive commissions.
When a client visits us for the first time, we determine what level of risk they would like to have their money managed, and then we put them in a portfolio that is reflective of that risk.
TWST: What portfolios do you have at present time to offer your clients?
Mr. Young: Our most popular portfolios are Managed Income which is conservative and Top Flight which is growth oriented. Many of our clients are in some combination of these two portfolios, depending on their risk tolerance. By combining the two portfolios clients are able to create a very custom, actively managed portfolio that is dialed in to their individual tolerance for risk. Both portfolios are based on tactical strategies and are constantly adjusting to the markets.
We also have strategic portfolios. Those portfolios are for clients whose primary focus is tax efficiency and want a portfolio with low turnover. Our strategic portfolios are traded much less actively and seek to generate long-term capital gains.
TWST: These have been a tumultuous few months in the market for investors, for both fixed income and equity. How have you done at Paragon?
Mr. Young: I have been through several rough markets during my money management career. We made it through the 1987 crash untouched. We also did relatively well during the 1998 Asian Crisis and the 2000-2002 bear market. This bear market has come together differently than any I have ever experienced. It really has been the perfect storm.
Our models are built to move us towards cash as markets become overvalued and into equities when they are undervalued. At the end of 2007, our models indicated the markets were at fair value. Unlike previous bear markets, this time valuations were not excessively stretched. Therefore we did not have large cash positions going into this bear market.
Also, our models are constantly measuring the strongest asset classes and moving into those asset classes. In previous bear markets moving towards strength has always cushioned the downside. Usually, there is always a bull market somewhere that you can benefit from. This time, there was virtually nowhere to hide. There was no bull market anywhere except treasury bonds.
While I’m not ever happy with losses, our portfolios did relatively well in 2008. To put it in perspective, in 2007 Top Flight returned 17% versus 5.5% for the S&P 500. We were able to triple the S&P 500 because our Top Flight was primarily invested in international markets at that time.
In 2008, those same international funds were down 47%. Top Flight, on the other hand was only down 33.8%. This year we experienced the worst declines Top Flight has ever seen. Over the past eleven years -13.6% had been our worst year up until this bear market.
Managed Income also did better than most conservative portfolios. Most of our clients have a mix of Managed Income and Top Flight, depending on their risk tolerance. As a result, that mix provided significant protection to our clients and most of them fared much better than the market indexes last year.
TWST: What is your outlook for 2009? Do you see any light at the end of the tunnel?
Mr. Young: The market is unbelievably oversold at these levels. We are back to the same levels we were at 13 years ago. When you consider the growth of the population, the advances in technology, and all of the gains in productivity it is hard to believe the market is priced the same as it was then. Stocks are incredibly cheap, and they are becoming more and more undervalued each time the government announces a new solution.
Back in late September, Fed Chairman Ben Bernanke and treasury secretary Hank Paulson initially scared investors to death with a very public and emotional plea to congress requesting $700 Billion to bailout the banks. Next, the market sold down hard in October and November because of the uncertainty surrounding a change in political leadership.
After the election the market actually rallied over 20% as investors begin to believe that Obama would govern from the center, not from the left. At that point most market participants thought that we had seen the lows and would move towards recovery.
Then President Obama started talking. He promised stimulus and delivered pork. He promised fiscal responsibility and is projected to match George Bush’s entire deficit in his first 20 months of office. Every day he comes out with another plan and another program. His treasury secretary seems lost. His policies sound more like socialism than free market.
Every time Obama talks the market tanks. Unfortunately, he likes to talk. Selling short every time Obama speaks has actually become a trading strategy because it was so successful.
I believe that if it weren’t for the foolish political mistakes this market would have turned back positive around 8000 on the Dow. Because of the extreme levels of fear we are in a spot where valuations don’t matter.
I believe that the markets will turn positive this year. This is very simplistic, but when we get to a point where President Obama can go on television and speak…and the market goes sideways or up….then I think we will be very close to a bottom.
TWST: Please describe your investment process for the Top Flight portfolio. How do you attempt to control risk?
Mr. Young: Top Flight is managed using two unique groups of quantitative models. The first group of models is proactive in nature and determines which areas to invest in. The second group of models is protective in nature and determine how much of the portfolio will be invested in equities and how much will be in cash at any point in time.
The proactive set of Paragon models is designed to identify trends and measure velocity within the universe of available market styles, sectors and industries. When trends are identified, the portfolio stays invested in those market styles, sectors or industries until certain exit criteria are met. When an exit criterion is met, the funds are rotated into other areas that currently meet the model’s recommendations. This rotation is ongoing, and the models are constantly adapting to current market conditions.
The protective set of models is designed to reduce risk while achieving a high return on investment. These models determine how much of the portfolio will be invested in the market. This percentage is based on how much risk the model measures at that point in time. When the model shows that there are high levels of risk in the markets, the portfolio holds more cash. When the model shows that there are low levels of risk in the markets, the portfolio becomes fully invested. The equity exposure in the portfolio changes depending on market conditions and will range anywhere in between 0% and 100% net long.
Top Flight invests primarily in exchange traded funds that concentrate investments in various classes of equity securities, which provides your portfolio with the greatest focus and flexibility.
TWST: What has been the return of the Top Flight portfolio since its inception?
Net of all fees, for the eleven year period from 1998-2008, Top Flight has delivered a total return of 242.1%. During that same period of time the S&P 500 returned only 11.7%. On an annualized basis, that works out to 11.93% for Top Flight versus 1.03% for the S&P 500.
TWST: We haven’t discussed your conservative portfolio. Could you expand more on your Managed Income portfolio.
Mr. Young: This portfolio’s objective is to generate higher returns than bank certificates of deposit or traditional bond portfolios without the volatility normally associated with the stock market. This portfolio is managed using some of the same techniques that Top Flight, Paragon’s growth portfolio originally pioneered, but with a much more conservative approach.
The principal asset classes we rotate between include bonds, real estate, utility stocks, bank loan funds, convertables, preferreds, alternatives, low volatility funds and money markets.
This portfolio is managed by processing market data through separate quantitative models that measure asset class desirability. Paragon also uses models to screen several thousand ETFs and mutual funds within the target asset classes to determine which funds are ranked highest. At any given time, the portfolio may include 8 to 12 positions representing various asset class combinations.
Occasionally, as opportunities present themselves, a small portion (less than 20%) of the portfolio will be allocated to low risk / high probability short-term trades using ETFs or equity-based mutual funds.
To preserve capital, the portfolio will normally exit out of volatile positions at a much earlier stage than Top Flight, Paragon’s growth portfolio.
TWST: What gives your firm its edge? What differentiates you from other wealth management firms?
Mr. Young: We have a philosophy that places a premium on proactive management, proven quantitative models and exceptional client service.
Our fundamental roots lie in money management. The methods that we use are very unique within the financial services industry. Most advisory firms simply build a diversified portfolio then wait and hope, but we actively manage our clients portfolios on a daily basis. This includes using proprietary quantitative models to measure, monitor and adjust our portfolios as market conditions change. These portfolios have a strong history of outstanding risk adjusted returns.
In the financial world, experience and judgment matter more than anything. We offer our clients a proven 23-year record of success working in all types of market conditions. Since we opened our doors in 1986, we have continually improved our investment methods and client services. When clients invest with us, they receive all the benefits and advantages of that experience.
As a registered investment advisor, we have a fiduciary responsibility for every client we serve. That means we have a legal obligation to put their interests ahead of our own. It is estimated that only 15% of all financial advisors meet this fiduciary requirement.
To make sure our interests are always perfectly aligned with our clients, Paragon advisors never sell financial products or receive sales commissions. We only receive management fees for managing our client’s accounts.
With us, there are no hidden fees or surrender charges. Unlike most investments, clients are free to move their money out of our investment programs at any time if their needs change or they are not completely satisfied with our services.
TWST: Last time we talked, you talked about how important it is to measure the amount of risk an investor is taking, not just returns. Do you want to tell our readers more about that?
Mr. Young: Since my firm was founded on the importance of reducing risk I obviously feel that it is very important. I believe that it is useless to compare returns unless you also compare corresponding risk. We use the Ulcer Index to measure risk.
The Ulcer Index is different from other risk measurement indexes, such as standard deviation, beta and the Sharpe ratio, because it does much more than simply measure portfolio volatility. Traditional risk indexes falsely assume that all volatility is bad. The reality is that investors welcome upside volatility-but deplore downside volatility. The Ulcer Index accounts for this basic psychological fact by ignoring upside volatility and penalizing downside volatility.
Since its inception from January 1, 1998 to December 31, 2008, the Paragon Top Flight Portfolio has generated an Ulcer Index rating of 8.9, compared to 19.31 for the S&P 500 and 49.32 for the NASDAQ. The lower the number, the lower the risk level.
TWST: Are there any other topics or issues that you would like to mention in this interview that we haven’t touched on?
Mr. Young: We are in a very difficult time right now and a lot of investors are simply putting their head in the sand and waiting for this horrible market to go away. That’s understandable. The fact is there is some history to this situation. We have been through 34 bear markets in last 100 years. We’ve had four bear markets that are in the same category as the one we are going through right now, that had declines of 50% and more. After each one of the bear markets we have gone through there are certain areas of the market that show extreme strength when the market finally reverses.
After past bear markets we’ve positioned ourselves in those areas of the market that have traditionally shown the most strength. Those areas have come out three to four times faster than the broad S&P indexes. For example, after the 2002 bear market we had the 2003 a bull market. That year, the S&P 500 was up 28.6% but Top Flight was up 50.3% that same year, because we moved into those areas of the market that do well after bear markets.
This type of bear market we are currently going through usually happens only once or twice in an investor’s life-time. It is also a once in a life-time opportunity. It is important for investors to be in the right places on the other side of this bear market.
TWST: Thank you. (PS)