Markets Keeps Moving Up

The markets moved upward in January and February in a continuation of the positive trend of the last quarter of 2010. Corporate profits have been very solid despite the fear and uncertainty about the future. The market continued to push upward since earnings drove stock growth and stocks were undervalued. While there are a lot of varying opinions on just how strong the global recovery will be, there seems to be a consensus that we should see solid growth soon.

After five positive months of growth, the market looked a little tired. It had a tough time making progress in mid February. Investors usually start looking for reasons to sell and take profits when the market gets stretched like this.

The earthquake and tsunami  in Japan gave global investors a reason to sell, and the market sold off accordingly. This selloff was followed by the usual pessimists making their appearances on talk shows. They said it was the beginning of the next big market selloff, and it will slow global growth.

At the same time, we had a lot of turmoil in the Middle East and North Africa. I am not very concerned about this because I have watched drama in the Middle East affect the markets for the past 25 years.

The market sold off about six percent from mid February through mid March because of the issues in Japan and the Middle East. The market has vigorously rallied higher and fully recovered from the recent scares since those March lows.

In the final analysis, investors decided that corporate profits and potential future global growth trumped the headline events. Most leading economic indicators continue to be positive. Positive Job creation and the lowest unemployment rate in two years have helped investors feel better.

 Our Portfolios

Our conservative portfolio, Managed Income, continued its outperformance. All three months were positive with a first quarter return of 2.94 percent versus 0.43 percent for its benchmark, the Barclays Bond Index. This was difficult to accomplish considering the low interest, rising rate scenario we are currently in.

Our growth portfolio, Top Flight, started the quarter out slow, but then its performance accelerated in March. Our exposure to Health Care, Energy, Basic Materials and Industrials helped us during that difficult month. The Top Flight portfolio gained 5.2 percent for the quarter. Considering the difficulty that active strategies have encountered over the past year, we were glad to see the Top Flight portfolio perform well for the quarter. Since its inception in January 1998, Top Flight portfolio has generated a total return, net of fees of 430.1 percent versus 72.3 percent for its benchmark the S&P 500. (See full track record and disclosures on our Track Record page. Past performance is no guarantee of future results. )

Living with Uncertainty

Stock and bond markets incorporate all the available information at a given point in time when they operate efficiently. We saw other European countries with potential difficulties when sovereign debt problems emerged in Greece early last year. Along the same lines, we also saw an immediate spike in the cost of insuring their debt. The market factored this possibility in even though they had not run into problems yet.

Market analysts spend many thousands of hours each year looking at these kinds of issues. Slow-forming problems like government debt issues can be analyzed beforehand with enough time and research.

Unpredictable developments that cannot be anticipated such as these:

• The volcanic eruption in Iceland that spewed ash in the air, shut down 100,000 transatlantic flights, and cost the airline industry $2 billion.
• The explosion of the Deepwater Horizon oil rig in the Gulf of Mexico.
• The street protests resulting in changes of leadership in a number of countries in North Africa, leading directly to the current military action in Libya.
• The earthquake, tsunami, and nuclear-reactor crises in Japan.

Set Your Risk Tolerance

The only way to handle uncertainty and manage the impact of unforeseen events is to build strict risk controls into your portfolios. While the risk of one-time incidents can't be eliminated, through diversification and risk management we hope to  limit the damage when negative events such as massive frauds like Enron, sudden bankruptcies similar to Lehman Brothers, volcanic eruptions, oil rig explosions, or earthquakes occur.

Considering this, it might be useful to provide an overview of our approach to risk management and portfolio construction. The first step towards controlling risk is to make sure that your individual risk tolerance is set properly.

Your risk tolerance can depend on many factors, such as how close you are to retirement, your goals, or your lifestyle needs. It is determined by the returns you need to generate in order to meet your objectives and by identifying how much risk you are comfortable with and can handle. If your risk tolerance is set too low, you will not generate the returns you should. If it is set too high, you will feel pressure to sell your investments if market conditions become difficult, which could cause you to miss out on superior long-term returns.

Once your risk level is set it helps us identify the mix of stocks, bonds and cash you should hold in your portfolio. It determines how conservative or how aggressive your portfolio should be. The allocation that we put together based on your risk tolerance strongly determines how much volatility you will have to endure when unexpected events occur. 

Risk Tolerance is different for each of our clients because each one has different needs. If you have any questions or concerns about your individual risk tolerance please contact us, and we will help you make sure yours is set correctly.

Use Models to Reduce Risk

The second step to reduce risk is the actual process we follow to manage the portfolios. We seek to manage risk by 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 aggressively the portfolio will be invested 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 when possible. These models determine how aggressively the portfolio will be invested at any point in time. When the model shows that there are high levels of risk in the markets, the portfolio reduces market exposure. When the model shows that there are low levels of risk in the markets, the portfolio becomes more fully invested.

In Summary

We've always had unexpected events, and these will continue going forward. and always will. Despite these unforeseen events, economies have grown, companies have prospered, and stock markets have generated positive returns. The key to benefiting from this long-term growth is to structure your portfolio so that no single event can create permanent damage to your portfolio.

We will work through the recent events, and investors with a balanced approach and a long-term view will be well rewarded. Our goal is to help you reach your goals with the least amount of stress and distress along the way.

As always, we appreciate the opportunity to work with you.