Press Room

< back to News
Jun 30 2009
So Far the Stock Market is Looking Good
Dave Young
Since the March 9th low, the market has been in rally mode. Amidst a backdrop of naysayers, the S&P 500 gained 16% for the quarter and has finally pulled positive with a year-to-date return of 3.16% through June 30th. The rally has been global in scope, with almost all sectors and countries participating. Global stock markets had their best quarter in over 20 years. For the most part, last year's worst performers were this year's best.

Both of our investment portfolios outperformed their benchmarks. Our conservative portfolio, Managed Income, is up 2.89%. Our growth portfolio, Top Flight, is up 8.65% year-to-date, versus 3.16% for the S&P 500. Since its inception in January 1998 through June 2009, Top Flight extended its gains to 272% versus 15% for the S&P 500. (That is not a typo).

Last quarter, as the media proclaimed the world was ending, we said investors should position themselves in the areas of the market that historically perform the best after a bear market. We also strongly recommended that investors avoid treasury bonds. Last year's treasury bonds were the only decent performing asset class. As a result they became very popular, just at the wrong time. So far this year, treasury bonds have moved from first to worst and are one of the worst asset classes, with the Barclays Long Term Treasury Bonds Index down -12.25% year-to-date.

Once again, undisciplined investors moved to the "safety" of treasuries after getting beat up in stocks, just in time to get beat up again. On the other hand, the areas of the market that usually do well after a bear market have performed exceptionally, just as we expected. From the March 9th lows through June 15th, the sectors we recommended performed as follows:  Financials +94%, Industrials +50%, Materials +49%, Consumer Discretionary +46%, Technology +43%. On a macro basis, growth outperformed value and emerging markets beat developed markets. Our focus on Brazil and China significantly benefited our growth portfolios.

BENEFITS OF RISK MANAGEMENT

As I mentioned, our growth portfolio, Top Flight, generated a total return of 272% versus only 15% for the S&P 500 from January 1998 through June 2009. Investors often assume our portfolios take more risk because our returns are high. Actually, the opposite is true. Avoiding large losses has generated much of our excess return.

For example, in the recent market cycle, January 2007 through June 2009, the S&P 500 lost 31.4% of its value. Many investors have done even worse. During that same period, our actively managed Top Flight Portfolio was down only 15.9%.

To accurately compare performance, the most important question to ask is, "How much of a return is needed by each investment strategy in order to get back to even?"

Calculating percentage returns is different than most investors realize. For example, if you have a 25% loss, you need 33% to get back to even, which is workable. If you lose 50% of your portfolio, you need to make 100% to get back to even, which is obviously a much more difficult task.

For example, let's compare Top Flight to the S&P 500. For Top Flight to recover its 15.9% loss it only need to earn 18.9%. For the S&P 500 to recover its 31.4% loss, it will need to earn 46%. As you can see, the size of the loss has an exponential negative effect on an investor's ability to recover. It will take investors in the broad market (S&P 500) almost three times as much effort just to get back to even versus Top Flight.

Avoiding large losses is critical to long-term success. Investors must follow a disciplined, non-emotional, long-term, proven investment strategy if they want to succeed.

SHOULD I INVEST NOW OR WAIT?

This seems to be the million-dollar question for investors on the sidelines. The same voices that expected the markets to continue downward three months ago still expect more decline. As a result, they have missed one of the biggest quarterly rallies in recent history. Since they missed the rally now, most are forecasting (and hoping) the market will decline so they will have a chance to invest later.

So far, every time the market tries to sell off, investors that missed the initial rally pile in. It appears that some of the money on the sidelines comes in during every sell off, and that is what has kept the market going up.

Should an investor jump in now or wait until the market goes back down?

I have been asked this question several times in the past six months. It would be helpful if we had the ability to see into the future, but obviously that isn't the case. Instead, we look at history and probabilities for guidance.

In our growth portfolios, we have been fully invested for the most part since the March lows. During the past couple of weeks, we have reduced exposure and raised some cash because our indicators show the market overbought in the short-term.

We seem to be stuck in a trading range between 865 and 945 on the S&P 500. As our indicators move back towards fair value, we will likely move back to 100% invested. Since our long-term models are positioned bullishly, our bias is to be 100% invested and "buy the dips" for the foreseeable future.

Even if I didn't have the benefit of using sophisticated models, I would still want to be fully invested because we know the economy will eventually recover. We just don't know when.

On average, recessions last between six and 16 months. At the end of June we were about 17 months into it, making it one of the longest ever. Every month the recession continues the odds increase that the economy will turn positive.

Historically, expansions tend to be long and recessions are usually short. In the past, positive expansions have lasted three times as long as recessions. We want to be invested as the economy moves from recession back to expansion.

If we assume the economy will eventually return to expansion, is the market reasonably priced today? In other words, is this a good entry point for new investors? Depending who you talk to, arguments are made claiming the market is ridiculously cheap or the market is outrageously expensive. Both sides use complicated metrics to make their case.

From a simplistic standpoint, the Dow Industrials was at 14,000 18 months ago and fell all the way to 6,500, which is a 12-year low. In inflation adjusted terms, it was a 43-year low. In my investing experience, the market seems incredibly cheap. While I don't expect the Dow Industrials to be rushing back to 14,000 any time soon, I do think the current level around 8400 is too low. I believe this market is still pricing in a worst-case scenario rather than reality. Historically, after a huge sell off, the markets deliver good returns over the next several years.

Finally, the stock market is a leading indicator. Many investors want to wait until the economy is back to normal before they invest. That strategy doesn't work. Investors who wait for confirmation that the economy has recovered before will likely miss the bulk of the returns that usually occur after a bear market.

Historically, long before the economy is back to normal, the stock market has fully recovered. In other words, the stock market has always moved up before the economy recovers. Watching the economy for clues of when to invest doesn't work. Watching the stock market itself gives investors better clues of when to invest after a decline. Historically, getting into the stock market while the economy is still in recession has proven to be a good strategy