View the Stock Market as a Series of Trading Ranges

For many years, Abby Joseph Cohen, Senior Investment Strategist at Goldman Sachs, has been a welcome voice of reason and counterpoint to the shrill hucksterism that permeates much of Wall Street commentary these days. In a recent Business Week interview with CNBC’s Maria Bartiromo, Ms. Cohen said:

“…the market should be viewed as a series of trading ranges [a trading range is the spread between high and low prices over a period of time]. Forget the U, forget the V; it looks like a staircase. We’ve had a very significant upward step from March. And we think that the next step will also be upward. There are two very important things here. Number one, we think the recession will be ending. We think that GDP will be positive in the second half of the year. The other thing that will look better will be corporate profits. Keep in mind that we’re getting to some extremely easy comparisons. The third quarter of 2008 was dreadful. So those comparisons are going to look great. Also a bit of an optical illusion is that some of the companies in big trouble that were in the S&P index a year ago, may no longer be there. But the third thing that is more important…is that we do see profit margins picking up.”

As Ms. Cohen noted, because stocks have come so far, so fast since bottoming out in early March, a pause or even modest pullback is not cause for concern. The greater danger is stock valuations getting too far ahead of themselves, setting the stage for a more substantial correction. Think, two steps forward—one step back; two steps forward…

Extreme Makeover Wall Street Edition

Sentiment on Wall Street underwent an extreme makeover during the second quarter as investors’ collective mindset shifted dramatically from loss avoidance to capital appreciation. “Overall, the second quarter brought a global sigh of relief that we are evidently not falling into a bottomless pit,” said Stewart Schweitzer, Global Markets Strategist at J.P. Morgan Private Bank.

The distinction between “not losing money” and “making money” cannot be overstated and is easily forgotten, even ignored, when fear runs rampant. The former involves risk aversion behavior while the latter requires risk seeking behavior. Thought of this way, it’s easy to see that these two approaches are opposites that require equally opposite investment strategies to achieve. The trick to reconciling these seemingly mutually exclusive states is as follows (in order):

1. Remain focused on capital appreciation, or making money; in good times and bad. Do not let market turmoil change your mindset lest you lose sight of why you invested in the first place (and your goal!). The portfolio strategy you designed to maximize total rate-of-return over your personal investment time horizon is not changed by short-term events (e.g., economic recession).

2. Distinguish between temporary capital losses & permanent capital losses and reconcile yourself to accepting temporary losses in exchange for higher long-term rates-of-return. This requires the temporary suspension of your average annual rate-of-return expectations during short-term market corrections and more prolonged bear markets. Your long-term average annual rate-of-return expectations remain unchanged.

3. Rebalance your portfolio’s asset allocation as aggressively as your frayed nerves will allow to recover from temporary capital losses and ultimately achieve higher long-term rates-of-return. I acknowledge that the positive impact of rebalancing, diversification, etc. is diminished when virtually every asset class tanks as occurred in 2008. Thankfully, global meltdowns like that one are rare and constitute an exception to the rule. Bottom-line, nothing is 100% fool-proof, 100% of the time.

Did Your Portfolio Participate in the Rally?

Too many investors are content to look at the dollar change in their total portfolio value at the end of a period and, if it’s positive, conclude that they’ve done well. This is too simplistic. Just because the market did well does not guarantee that your portfolio did too. It’s important to know if your portfolio benefited in proportion to the market’s gains. Good for you if it did. However, if it outperformed or underperformed, that could be a call to action.

Consider that emerging market stocks, real estate investment trusts, and financial stocks were decimated by the recession. Share prices collapsed as investors sold them in droves in favor of the perceived safety of U.S. Treasury bonds. Consequently, these assets are under-represented in many private portfolios. “Good riddance,” you might say. Yet emerging markets, REITs and financials led the second quarter rally with gains of +25%, +29% and +35%, respectively. In India alone, the benchmark Sensex Index gained +49% in just 12 weeks. As we’ve seen again & again, yesterday’s laggards often become today’s leaders.

Conversely, the safe haven many investors sought, U.S. Treasury bonds, declined -3% for the quarter, taking its losses for the first half of the year to -4.4%. This is the worst six-month performance in the history of Merrill Lynch’s Treasury Master Index, according to the Wall Street Journal. The benchmark 10-year Treasurys lost as much as -6% on the quarter. Riskier corporate bonds and high-yield “junk” bonds gained +23% for the quarter underscoring investors’ new appetite for risk.

Where Does the Rally Leave Us Now?

Some argue that the market has gotten ahead of itself and is due for a pull-back. Others believe the recent rally is a bear market trap and further declines lie ahead. Even Treasury Secretary Geithner conceded that the current recession isn’t over and a double-dip recession is possible. Looming inflation is an ongoing concern, as is the stability of the U.S. dollar. These are real concerns that cannot be discounted.

My view is that we are at the end of Round 1; still early in the fight, with significant opportunities remaining. A pull-back in stocks of as much as 10% would not be surprising or unwarranted and serve only to extend the current buying opportunity. The strength of corporate earnings in the second half will determine the direction of stock prices in coming quarters. Earnings are currently showing tepid signs of strengthening.

Easing of the credit crisis has restored some stability to the bond markets as evidenced by the rally in corporate bonds and several successful new issuances. Municipal bonds remain problematic as municipalities struggle with falling tax revenues.

On balance, I believe that the outlook for a positive end to the year is bright. There is a significant possibility that economic growth (GDP) will return, marking an end to the current recession. Should that occur, the unemployment rate will peak and then begin to decline, giving a further boost to investor sentiment and overall consumer confidence.


Timothy R. Meyer
President & Chief Investment Officer

Advice is Everywhere But How Useful is It?

You may have noticed that as the recession and credit crisis drag on, all manner of advice on how best to deal with falling stock prices, declining home values, rising unemployment, etc. has proliferated. It’s fair to say that there is a raging bull market in the advice business these days. Two reasons account for this. First, in the context of a crisis environment such as we face currently, the need for sound advice is more important than ever. Second, sensitized as we are by the hit(s) to our financial wellbeing, most of us are simply more receptive than usual to guidance from credible sources. We’re all seeking answers.

Unfortunately, the quality and, by extension, utility, of much of the advice currently flooding the airways is dubious at best. For example, a recent headline caught my attention by trumpeting “Here’s How to Save Your Retirement.” I thought ‘What’s not to like about that,’ as I flipped to the first page. It took only a few moments of reading to discover the secret formula for saving our collective retirements: “save more” and “spend less.” That’s it…simple as that. Save more—spend less. Under-whelming? I thought so too.

In a world where home foreclosures are skyrocketing, most people don’t have the income to save more, to state the obvious. Spend less? Most Americans, including even the super-rich, have already cut discretionary spending to the bone just to keep their heads above water, let alone boost their savings.

That bit of wisdom got me thinking about other insightful nuggets that I came across so I decided to share some of them with you here. The headlines that capture our attention in this way are invariably well written and promise clear, concise answers to vexing problems. It’s the material following the headlines that under-whelms and may even mislead.

1. Build a Stress-Free Financial Portfolio. What could be better? We could all do with a little less stress in our lives. Unfortunately, the article recommends a portfolio consisting entirely of certificates-of-deposit, money market mutual funds, and US treasury bonds all yielding between 1.00%-3.75%. This approach is indeed protected from capital loss and unsettling price volatility. Safety comes at a price, however. How many people can realize their retirement dreams or college saving objectives on such a low total return? Not many. Moreover, after adjusting for inflation and taxes, the real rate-of-return will be even less. That could really cause some stress!

2. 5 Ways to Stretch Your Savings. Make your savings go farther and last longer; excellent idea and another attention grabber. The first of the five secrets…don’t retire…keep working. Never mind those people that don’t want to work into their late 60’s or 70’s, whose health won’t allow them to work longer, or that get laid off, downsized, etc. and can’t find a suitable job or one that pays a comparable salary.

3. 4 Ways to Tame Your Fear of This Market. Taming fear is good. Lots of people today are just plain scared. The solution? Allocate a larger portion of your investment assets to fixed income securities like bonds. This makes sense in principle, but isn’t as easy as it seems. First, all investors with exposure to stocks have seen the value of these assets decline since the market peaked in late 2007. Many have incurred sizable unrealized losses even on quality, blue-chip holdings that are likely to perform well as the recession ends and the economy recovers. Selling stocks now in order to re-allocate to bonds realizes or locks-in those losses. While bonds pay steady interest, their total return is unlikely to match that of stocks as the economy starts to grow again. Taming your fear in this way could cost you a lot of money which is, in itself, frightening.

Further, if the crisis has shown us anything, it’s that even the safest investments are not as safe as we once thought. Prices of some mortgage-backed bonds and bonds of commercial & investment banks, auto makers, etc. once thought to be rock solid, have been as volatile as stock prices. Just ask General Motors bondholders.

4. Safe Moves in Today’s Market. Safety is definitely in vogue as investors have become more risk averse and less risk seeking. This source suggests that a good way to begin building a “safe” portfolio is to buy the S&P Dividend SPDR (SDY). This is an exchange-traded index fund that holds the shares of 52 blue-chip, dividend-paying common stocks. The only problem is that SDY has traded down by as much as 53% in just the last 12-months! Most investors would not consider a capital loss of that magnitude paramount to “safe.” This is not to say that SDY won’t prove to be a fine investment over time. It simply underscores what most investors already know in their hearts, which is that investment risk & reward go hand-in-hand. You cannot benefit from the latter without incurring the former.

5. Make Yourself Recession-Proof. Can we really do that? In a word…NO! The central piece of advice here is to hold on to your job. Yet, how many people lose their jobs by choice? None that I know of. Few people have any significant influence over personnel decisions in their workplace. Sure, we should each maximize our value to our employer and make ourselves as indispensable as possible but 1) it’s to our benefit to do that all the time, not just during recessions, and 2) corporate downsizing decisions are not generally made on an individual-by-individual basis. Doing that is called discrimination and it’s illegal.

Be careful as you read & listen to the advice swirling around today. If it sounds too good to be true...it is! As much as we would like there to be easy answers to the challenges we face, those are few & far between. That doesn’t mean that answers don’t exist. They do. Trust your instincts, first & foremost, and seek out competent professional help when you feel it necessary. Remember, the current recession will end as all the others before it ended. Stock prices are in the midst of a robust month-long rally and bond prices show signs of stabilizing. Recent economic data provide cause for optimism and attractive investment opportunities abound.


Timothy R. Meyer
President & Chief Investment Officer