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Here We Go?

       If you are thinking that means going into a massively destructive bear market, again, the answer is no.  If you are thinking that means the markets are doing exactly what we’ve been talking about for the last 6 months, then right you are!

 

But If You’re Such a Genius….

 

            You might be thinking, well Sam if you’re so damn smart, why aren’t we up 20% YTD?  Why did my account lose money last week?  There’s an easy answer.  Success with asset management is a game of experience, behavioral economics and trend recognition.  It is about understanding real risk and seeking asymmetric returns.  In our shop, we define success as follows (part of our Explicit Investing Creed):

Explicit Investing Creed of ASFA:

We are seeking Success over a reasonable Judgment Period by knowing when to embrace and reject conventional wisdom regarding perceived market trends, Risk and opportunities. Superior, above average, results over time are only achievable through unconventional decision-making, conviction, and discipline.

 

Risk (defn.)

– The probability of unrecoverable or semi-permanent loss of capital, not to be confused with variable degrees of periodic volatility.

Success (defn.)

– Generating asymmetrical results across all investment strategies: to expose ourselves to return in a way that doesn’t expose us commensurately to risk, and to participate in gains when the market rises to a greater extent than we participate in losses when it falls.

 

Judgment Period (defn.)

– A period of time that captures a full investing cycle including both bull and bear markets – typically any rolling 5-6 year period.

Inherent to all of this talk is the reality that we cannot avoid risk altogether but rather we manage it, accepting periodic losses at different times in pursuit of steady gains over time. 

 

We Talked About This

 

            I’ll give you a few reminders of our discussions over the past 6 months. 

 

Transition year!  Remember that?  This is a transition year in which the markets will digest gains from 2013 as well as begin orienting to a market environment that does not rely on so much influence by the Federal Reserve or monetary policy.  Can it happen without some bloodshed?  I am doubtful but neither do we need to fall back into another generational bear market.

 

Garden Variety Bear Market!  Remember That?  Yes that’s what we expect, nothing more nothing less.  These events can be scary.  10-20% is normal.  From our lofty heights having seen little more than 4% corrections in the last 24 months, it’s going to feel like a very cold shower.  We will play strong defense if and when this event occurs but plan to see your portfolio balance move down a bit as we seek “asymmetric returns”.  This process may have already begun.

 

Last Year’s Leaders Will Not Be the Same This Year!  Remember that one?  Indeed, last week’s action offered an obvious reminder.  Industrials, Small Caps and Consumer groups took the brunt of the selling.  These were last year’s winners and are now down on the year.  In fact, the entire US stock market is barely up YTD now after 7 months of “Transition”.  Treasury bonds, which performed badly in 2013, are one of the best YTD performers, the same goes for Asia and Emerging markets.

 

Adjusting to a Rising US Dollar! – Another One.  In the last 30 days, the US dollar has risen almost 2% against all foreign currencies.  This is a huge move in such a short time and certain one that is now overdone.  But the technical pattern for the US dollar is now looking decisive, showing a long term bottom and potentially the beginning of a new long term uptrend.  A rising US dollar is to be expected as the US economy hits the upper end of capacity (employment and manufacturing) and growing with stable demand and shrinking government printing and spending of US greenbacks.  A rising US dollar is hard on commodities, which are now in a downtrend, hard on gold (as a contra-dollar trade) and hard on companies that generate a lot of foreign revenue (industrials and consumer staples).  The only oddity this year is the massive underperformance of small caps, which tend to do better in periods of a rising US dollar.  I’ll be watching this relationship and doing some additional research on this so stay tuned – something strange it happening with small caps. 

 

          Stick With Late Cycle Leadership (last week’s “Shifty” update).  These are Energy, Technology and Healthcare predominantly as major food groups.  On the bottom of the list are materials, telecoms, and utilities.  Last week, energy took an enormous hit (-4% on the week), which challenges this theme.  Technology and healthcare did ok.  We were stopped out of a few energy positions but still holding many others.  Utilities are also bucking the trend of what “should” be happening now as one of the strong sectors YTD.  Materials and telecom gave gas as instructed.   For the second half of 2014, I’m going to expect our leaders and laggards to work extra hard to get back in line (energy up, utils down mostly).

 

          Finishing on a positive note – the bull market is not over.  We haven’t yet seen much expansion in valuation measures, we haven’t yet seen sentiment shift into the bullish camp and we haven’t really seen substantial money flow into equities and out of bonds.  Technical warning flags are non-existent.  Meanwhile, the economic news is all favorable, earnings are still strong, getting stronger, interest rates are benign, inflation is barely on the scene and the Fed is still supportive for at least another 6-9 months.   Furthermore, we are working our way through one of the softest parts of the year and the presidential cycle without too much pain and suffering.  I would love a 15-20% correction but I’m doubtful we’ll get one as I am not alone in my interest to buy any discounts.

 

That’s it for this week – spend some time with the family and enjoy the rest of summer.

 

Cheers

Sam Jones