2010May13 Are You Confused, Yet?

 

The past few years should be confirmation for most investors that the current market environment has changed from the 80s and 90s “buy and hold” or “buy the dips.” Even academia has been quietly transitioning. Recently, a major financial journal concluded that the 90% impact of asset allocation is “folklore[i].” Modern portfolio theory cannot explain investor behavior or the development of sustained trends in securities. Even some Nobel Laureates have all but abandoned their own published work on rational markets.[ii]

 

Most financial advisors have told clients to stay invested or miss the big up days after significant declines. A recent Forbes^® column researched this overly used argument.

“An investment in the S&P 500 Index for the period 1990 to 2008 in a buy-and-hold mode returned 5.0% annualized, yet if you missed only the 40 best days your returns would have been an annualized loss of -4.92%; case closed, timing does not work.

Wait a minute! The engineer in me says let's look a little further. If you had instead missed only the 40 worst days during that same 1990 to 2008 period your investment returns would have skyrocketed to 16% annualized per year, more than triple the rate of return of the buy-and-hold strategy.” [iii]

We have moved into an economic era that has been repeated throughout history, but, this time, we are doing it globally with technology. Massive sovereign debt has occurred repeatedly in the past. Resolution came by warring with a neighboring country, confiscating assets of citizens (a.k.a, subjects) or inflating currency until it collapsed.

The problems in Greece cannot be resolved by lending them more money any more than alcoholism is solved with more alcohol. Spain and Portugal are not far behind. More importantly, Great Britain has run into its own brick wall of reality as its deficit will soon be the largest in the EU, surpassing even Greece.[iv] Unfortunately, the Administration and Fed do not seem to understand that the United States is not far behind.[v]

Remember Alfred E. Newman? “What? Me worry?”

And why should we? After all, Japan has survived similar problems since 1990 without their world coming to an end. Japan had a growing global economy to carry it along. Japan had its own population buying its government debt. Japan was and is very unique in ownership of government debt.

We are now borrowing money from China and Japan to lend money to the IMF to lend to Greece without any collateral or absolute provision for repayment. If delinquency occurs, the loan will be renewed. I have never met a banker with that much compassion. Have you? Our federal tax dollars are feeding this.

The “Flash Crash” of this month is a sure sign that “It can’t happen here” is one more financial myth. It should have been debunked after the “Asian Contagion” of the mid-90s. It should have been debunked after the “Tech Bubble” when corporate shells with Internet in the name sold for millions of dollars.

Harry Markowitz claims his Nobel Prize winning work resulting in modern portfolio theory was never intended to provide protection in down markets.[vi]

Nassim Nicholas Taleb,author of “The Black Swan: The Impact of the Improbable,” has said: “Asset-class diversification remains desirable but is not sufficient.”[vii]

Using the relative strength of security prices reportedly began with Charles Dow in the late 1800s and was called “figuring.” It was part of Benjamin Graham’s investment process. Today, it is referred to as Point & Figure. Even Morningstar^® is going to add relative strength measurements to its reports.

If you are ready for a relative strength analysis of your asset allocation and portfolio, call us. The analysis and discussion is free. Clarity just might replace confusion.

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