At Astor we are known for creating portfolios of ETF’s using employment trends as a key factor. Research and history have proven that employment trends are an excellent indicator of the long term direction of the economy and sectors. Of course it is not a one-to-one correlation and sometimes employment trends lag a bit, but for my money sticking with the employment trend keeps you out of trouble.
Look at recent history for a few examples. Employment trends kept me out of trouble in late 2000, sitting out much of the pain of the dot com bust. Fast forward seven years, and identifying a contracting labor market in late 2007 just before the subprime debacle saved you a lot of pain, fortuitously. Now that the current recovery is well underway and an expansion is upon us, employment trends can help balance a portfolio by investing in the sectors with the greatest employment growth.
With the latest data on the US labor market released last Friday, new clues as to where the best opportunities lie are available. This will most likely be a very boring, albeit useful and informative article. I promise to have a bit more wit and even humor in the other article posted during the month. There will be, of course, short term opportunities presented with other data points, political events and economic releases, as well as cute moves to capture short term fluctuations using ETFs. My hope is to regularly identify these opportunities as they present themselves. All that withstanding, the employment report is still the grand daddy of reports to build a road map to long term directions and sustained investment goals and objectives.
As I review the latest report areas of strength, those that jump out are the following:
•Healthcare – added 34,000 jobs. Investors can purchase the iShare Dow Jones Healthcare index (IYH) to get exposure to this hot sector.
•Manufacturing – added 33,000 jobs last month. A way to play that growth is in the MZG, the claymore Morningstar super sector of companies that make stuff.
•Construction- Although construction added 33, 00 jobs, recall that it lost 2,200 jobs in January so I would not jump on board yet in this area or related business.
•Transportation – Added 22,000 jobs mostly in trucking. The iShares IYT is an excellent ETF to capture this growth. With energy prices on the rise, this will be counter intuitive and should climb the preverbal wall of worry.
The big losers (from a jobs stand point) were state and local governments which have shed 377,000 jobs since the peak in 2007. I would be careful here and not rush to sell securities related to these municipalities, such as MUNI which is the ETF that tracks the muni bond market. The default rates are very low for munis and one or two bad apples should not spoil the whole bunch, but it could add unnecessary volatility to your portfolio (read opportunity as well).
Our lesson from an employment perspective is that if you add exposure to sectors that are adding jobs and reduce to the sectors that are losing jobs, you portfolio should have lower risk and volatility. After all, job growth is a sign of health and confidence, and pockets of strength are always good. Of course there is no magic bullet that can prevent the economy from losing steam and reversing course but these sectors tend to hold up better in a down turn and run farther in the expansion.
Sunday, March 20, 2011
Monday, March 14, 2011
The Time and Place
Much has been written to vilify levered ETFs. In fact, many blame them for the equity market volatility of recent years, specifically the flash crash of May 2010. I find this generalization frustrating. After all, it is just about math.
Leveraged ETFs may not track the index exactly over the medium to long-term. They may even be downward-sloping, meaning they are more likely to go down rather then up due to the effect of daily rebalancing. But, again, it is just math. The daily rebalancing impacts the long-term return and if the market is not trending it has a negative impact on price performance in comparison to the corresponding benchmark. That said, leveraged ETFs have a definite time and place and the best use is to capture short-term moves. With reduced capital requirements, an investor can hedge an entire portfolio without having to sell or raise cash. Or, if an investor is expecting a short-term move (up or down), and wants to take advantage of the short-term volatility it can be done with limited stress on the funding levels. Whether you are a hedger or an outright speculator, there is a benefit to be had from a product like this.
This is all a long lead-in to a recent phenomenon I have noticed in the major indices that have been occurring on the first day of the month. An abnormally high percentage of each month’s return, in the S&P 500 for example, has occurred on the first day of the month. Since the bottom was reached in the S&P 500 in March 2009, we have had 23 first days of the month. Of those 23 periods, the first day of the month has been the same direction as the rest of the month 17 times, or 73.9% of the time. The average return of each month since then (4/1/2009) is 2.35%. The average return of the first day of these months is 0.8%, or 34%. If we look at these numbers since January 1, 2010, these figures become more significant even. In the 14 measurable periods since then, the average monthly return for each month has been 1.35%. The average return for the first day of each month has been 1.05%, a staggering 76%.
There is an additional, equally alluring component to the “first of the month” phenomenon of late. Since April 1, 2009, 82.6% of the “first days” (23 total) have been positive, averaging 1.33%. Of the four days that were negative, the average return is -1.71%. The average return for all days in this sample was 0.81%, with the best day at 2.95% and the worst at -2.58%. A more recent view of this trend paints a similar, more compelling picture. Since January 1, 2010, 12 first days of the month have seen the S&P 500 rally, with only two showing a decline. The average return on positive days has been 1.4%, with a -1.02% on the two down days. The best day in this sample is 2.95% still, with the worst day at -1.72%.
I believe this pattern is due to two things; bullish consensus with low conviction, thus creating a chasing effect on the first day of the month as frustrated investors that missed yet another positive month just buy everything as the new month gets under way, and simply a bull market trend. Bringing this exercise full circle, whatever the reason for this might be if this pattern continues into March this is the perfect use of levered ETFs to capture this pattern. Investors can buy highly levered ETFs like UPRO and SQQQ which give triple leverage to the long side of the S&P 500 and NASDAQ 100, respectively. Since this trade is trying to capture the movement of a single day this is the perfect scenario for these products. While I am not suggesting this pattern should continue to work, and of course past performance is not indicative of future results, if you wanted to “go for it” this is a time and place for levered ETFs. In the spirit of full disclosure, my logical mind would not typically invest much capital on a pattern that I can’t explain. It is hard to ignore what I would dismiss a statistic of this significance to mere coincidence,
More interesting is you can sit out the rest of the month which will clearly reduce the risk/return profile as the lowest risk position is out. So with month end around the corner and the first day’s pop to follow you might want to keep your powder dry.
Leveraged ETFs may not track the index exactly over the medium to long-term. They may even be downward-sloping, meaning they are more likely to go down rather then up due to the effect of daily rebalancing. But, again, it is just math. The daily rebalancing impacts the long-term return and if the market is not trending it has a negative impact on price performance in comparison to the corresponding benchmark. That said, leveraged ETFs have a definite time and place and the best use is to capture short-term moves. With reduced capital requirements, an investor can hedge an entire portfolio without having to sell or raise cash. Or, if an investor is expecting a short-term move (up or down), and wants to take advantage of the short-term volatility it can be done with limited stress on the funding levels. Whether you are a hedger or an outright speculator, there is a benefit to be had from a product like this.
This is all a long lead-in to a recent phenomenon I have noticed in the major indices that have been occurring on the first day of the month. An abnormally high percentage of each month’s return, in the S&P 500 for example, has occurred on the first day of the month. Since the bottom was reached in the S&P 500 in March 2009, we have had 23 first days of the month. Of those 23 periods, the first day of the month has been the same direction as the rest of the month 17 times, or 73.9% of the time. The average return of each month since then (4/1/2009) is 2.35%. The average return of the first day of these months is 0.8%, or 34%. If we look at these numbers since January 1, 2010, these figures become more significant even. In the 14 measurable periods since then, the average monthly return for each month has been 1.35%. The average return for the first day of each month has been 1.05%, a staggering 76%.
There is an additional, equally alluring component to the “first of the month” phenomenon of late. Since April 1, 2009, 82.6% of the “first days” (23 total) have been positive, averaging 1.33%. Of the four days that were negative, the average return is -1.71%. The average return for all days in this sample was 0.81%, with the best day at 2.95% and the worst at -2.58%. A more recent view of this trend paints a similar, more compelling picture. Since January 1, 2010, 12 first days of the month have seen the S&P 500 rally, with only two showing a decline. The average return on positive days has been 1.4%, with a -1.02% on the two down days. The best day in this sample is 2.95% still, with the worst day at -1.72%.
I believe this pattern is due to two things; bullish consensus with low conviction, thus creating a chasing effect on the first day of the month as frustrated investors that missed yet another positive month just buy everything as the new month gets under way, and simply a bull market trend. Bringing this exercise full circle, whatever the reason for this might be if this pattern continues into March this is the perfect use of levered ETFs to capture this pattern. Investors can buy highly levered ETFs like UPRO and SQQQ which give triple leverage to the long side of the S&P 500 and NASDAQ 100, respectively. Since this trade is trying to capture the movement of a single day this is the perfect scenario for these products. While I am not suggesting this pattern should continue to work, and of course past performance is not indicative of future results, if you wanted to “go for it” this is a time and place for levered ETFs. In the spirit of full disclosure, my logical mind would not typically invest much capital on a pattern that I can’t explain. It is hard to ignore what I would dismiss a statistic of this significance to mere coincidence,
More interesting is you can sit out the rest of the month which will clearly reduce the risk/return profile as the lowest risk position is out. So with month end around the corner and the first day’s pop to follow you might want to keep your powder dry.
Friday, March 11, 2011
The Not-So-Secret Alpha Weapon
As the equity markets around the world turned higher in Q1 2009, and were followed by the economy soon after, many investment managers began to lag the broad averages/benchmarks as a result of being defensive. (Can you blame them?) Figuring out how to play catch up was the question, and many investors turned to emerging markets as the secret weapon. And why not? The story sounded good. Most avoided the domestic financial crush simply by not having a banking system that could support leveraged “ponzi paper” that the US and Europe were good at creating. They didn’t have the same issue we had with deficits and housing. They did not avoid the global slowdown 100%, however, their growth potential as a whole looked outstanding as the world rebounded, and they were going to lead us out of the recession.
Emerging markets were going to be the next big thing in the investment world and the upside opportunity appeared limitless. The beta of these markets is historically higher than the developed markets, and as momentum turned it seemed like the perfect trade, creating an allocation opportunity to add portfolio alpha. Emerging markets’ correlation to US stocks grew, but who cares about diversification when everything is going up, right? ETFs became the vehicle of choice for investing in emerging markets and the growth in these products swelled, ultimately breaking into the top tier by fund assets, alongside the SPDR S&P 500 ETF Trust (SPY) and the SPDR Gold Trust (GLD).
As 2010 was a grind up to new recovery highs was complete the tortoise (developed market equities) strolled passed the performance finish line ahead of the hare (emerging markets). But from the recovery lows the previous two years we still saw a large disparity in returns between these two brtheren. To be sure, the total return of the iShares MSCI Emerging Market Index (EEM) from the beginning of March 2009 through the end of 2010 was 131.5%. This compared to a 77.47% return for SPY and a similar 77.59% return for the iShares MSCI Developed Markets ETF (EFA) over the same period. As we enter 2011 and assets continue to balloon, fundamentals are no longer supporting such an large allocation to emerging markets versus developed markets as the recovery matures. The commodity story, which helped bolster resource-producing economies and their currencies, has become long in the tooth and political issues are causing excess volatility. Fundamentals do matter as do valuations. As the slow and steady improvement in the US economy hits stride, the surer bet right now is the tortoise. Year-to-date through 2/9/10 has said it all. EEM is down 4.47% compared to a 5.18% gain in SPY. As we review the fundamentals that drive US stocks, even after the lost decade, they are positively sloped and respond in kind to growing and improving economic fundamentals. This is not always the case (yet) for emerging economies. It has yet to be proven conclusively that these equity markets reflect their economies for any continued period. In fact, I am not even sure emerging market equities are positively sloped. They present great runs followed by almost equal declines. So as the train gets crowded and is about to leave the station, smart money is (or should be) rotating out of emerging equities and into more developed markets and larger capitalization stocks. There will be a place and time to re-enter emerging markets for the “beta trade”, but that may be a few quarters and maybe up to few dozen percentage points from here.
Emerging markets were going to be the next big thing in the investment world and the upside opportunity appeared limitless. The beta of these markets is historically higher than the developed markets, and as momentum turned it seemed like the perfect trade, creating an allocation opportunity to add portfolio alpha. Emerging markets’ correlation to US stocks grew, but who cares about diversification when everything is going up, right? ETFs became the vehicle of choice for investing in emerging markets and the growth in these products swelled, ultimately breaking into the top tier by fund assets, alongside the SPDR S&P 500 ETF Trust (SPY) and the SPDR Gold Trust (GLD).
As 2010 was a grind up to new recovery highs was complete the tortoise (developed market equities) strolled passed the performance finish line ahead of the hare (emerging markets). But from the recovery lows the previous two years we still saw a large disparity in returns between these two brtheren. To be sure, the total return of the iShares MSCI Emerging Market Index (EEM) from the beginning of March 2009 through the end of 2010 was 131.5%. This compared to a 77.47% return for SPY and a similar 77.59% return for the iShares MSCI Developed Markets ETF (EFA) over the same period. As we enter 2011 and assets continue to balloon, fundamentals are no longer supporting such an large allocation to emerging markets versus developed markets as the recovery matures. The commodity story, which helped bolster resource-producing economies and their currencies, has become long in the tooth and political issues are causing excess volatility. Fundamentals do matter as do valuations. As the slow and steady improvement in the US economy hits stride, the surer bet right now is the tortoise. Year-to-date through 2/9/10 has said it all. EEM is down 4.47% compared to a 5.18% gain in SPY. As we review the fundamentals that drive US stocks, even after the lost decade, they are positively sloped and respond in kind to growing and improving economic fundamentals. This is not always the case (yet) for emerging economies. It has yet to be proven conclusively that these equity markets reflect their economies for any continued period. In fact, I am not even sure emerging market equities are positively sloped. They present great runs followed by almost equal declines. So as the train gets crowded and is about to leave the station, smart money is (or should be) rotating out of emerging equities and into more developed markets and larger capitalization stocks. There will be a place and time to re-enter emerging markets for the “beta trade”, but that may be a few quarters and maybe up to few dozen percentage points from here.
Monday, November 30, 2009
All That Glitters
Gold has become front-page investment news lately and I think it’s time to shed some light on the shiny metal that has no industrial purpose. We do have exposure to gold in our portfolios through the ETF SPDR Gold Trust (GLD). We have been holding gold since late 2007 and have recently reduced this exposure a bit. This is not a comment on our view but rather a rational decision based on correlation and reality. Gold over the long haul has a low or negative return (depending on how you measure it and if you adjust for inflation). Although many consider gold a hedge against pretty much everything, including currency devaluations, political and social unrest, and inflation, I believe this conventional view is flawed. Statistics do not prove that gold is a very good hedge. Actually, stock indices seem to outperform gold and outperform inflation (of course with greater volatility). On an inflation-adjusted basis, gold is still 50% below its all-time high set almost three decades ago while stocks, even after two 50% declines in that period, are up around 1000%.
In fact, it seems uncertain why gold should rise during inflationary times other than demand from other investors. For example, gold is up 33.5% YTD but inflation is down 2%. If gold prices are predicting future inflation then so should bonds, which should sell-off during periods of inflation, and TIPS, which move on inflation expectations. However, both are greatly unchanged from year ago levels and are down from earlier this year.
What is driving gold these days is something I call “investment demand for gold.” This phenomenon changed fair value for stocks in the 80s when anyone with a 401(k) or IRA needed to buy stocks regardless of the price. With the advent of easier ways to hold and own gold, portfolios are being reallocated to include gold in their asset mix. This is creating a new source of demand. Whether investors determine 5% or 25% is the appropriate portfolio holding is unclear. But until those portfolio shifts are completed gold will be supported. Once this shift has completed, gold should move less in line with stocks and more on diversification and correlation principals if not on inflation fears, political unrest and currency devaluations. Signs are on the horizon that this day is closer than you might think.
Monday, November 23, 2009
Buy Dollars Wear Diamonds?
We recently added UUP to the portfolio which give some long exposure to the U.S. dollar. The response was immediate from clients who were concerned about the “free fall” the dollar was experiencing and the negative press the dollar garnishes daily and the impact on the state of the American economy. I don’t see it that way and a further review of the facts looks very different than investor perceptions. Truth be told, I don’t know where the dollar is going any more then I know where stocks are going or, for that matter, any of our positions. What I do know is that each position collectively has a greater probability of going up than down at the current stage in the economic cycle. While any one position can be wrong we look at the portfolio as a whole, with the objective of making more money than we start with. What we have demonstrated, by rigorous analysis, is that the overall portfolio is positively sloped. It has high probability of being worth more in the near future with an appropriate level of risk. If I knew where any one position was going with greater certainty, then I would put only that position on and nothing else.
As for the dollar, I think it is misunderstood. I don’t believe the carry trade actually exists. Who would sell the dollar and buy currencies that have a positive carry of around 2% annually when the currency can move more than 2% against you in a day? It doesn’t seem reasonable. Furthermore, the current correlation to equities is not sustainable and in fact doesn’t even make sense that the stock market should go up when the dollar goes down. We are a net importing country. We buy more from other nations than they do from us. That means a weaker dollar makes it more expensive for us to buy foreign goods. While I know that it also makes it cheaper for other countries to buy our goods, the fact is that the net effect should be a negative. The dollar moves more on trade and investment flows than interest rate differentials. At least in the long run.
If you look at the dollar from a longer-term perspective things look a bit different. One year ago the dollar index was at 79.35 (the end of Q3 2008) and the NASDAQ was at 1584. Today the dollar is at 76.80 and the NASDAQ is it 1720 (as of Q3 2009). So the dollar fluctuated down about 3% while the NASDAQ rallied over 8%. I am not sure what the big concern is here. Adding a long dollar position to the portfolio reduced the volatility and drawdown of the portfolio with limited impact on the returns. In fact, when the markets were in a free-fall during Q1 2009 the long dollar offset much of that loss allowing the portfolio to withstand that drop and to participate in the rally with less risk. If we take a look at a longer time-horizon, such as from the two years when the S&P made its high in September 2007, we see even further the downside protection benefits of a long dollar position, as the dollar index was about 80.5 at that point and the S&P was above 1500. The dollar has fallen only about 5% since then and the S&P has dropped almost 30%. So I find it hard to connect the dots of a weaker dollar impacting the markets. Since inflation is one of the main culprits of a currency’s value, interest rates need to be raised to offset the impact of inflation. The core inflation indices are down over the past twelve months so that doesn’t pose an immediate problem. The bulgering debt burden appears to have some in the currency world concerned but demand for U.S. treasuries remains high and rates remain low which would not be the case if debt burden was hampering the credit markets. In the end it’s all about growth and I expect U.S. growth to exceed that of its trading partners. This should support a bottom for the dollar and eventually lead to a stronger dollar. And don’t worry as that can occur with a rising stock market, but it can also occur with a declining stock market. That is what makes this position so attractive.
Tuesday, June 23, 2009
Is the Recession Over?
Once again unemployment Friday released new information for me to review and, like the groundhog, try to make the prediction of how much more winter, I mean recession, we have left. As you know we at Astor focus rigorously on the employment numbers as we believe they speak volumes on the condition of the US economy at large as well as specific individual sectors.
It was this data that alerted us to be defensive as early as December 2007 and indicated that a slowdown was in the offering for 2008, and it will be this data that will signal the all-clear to be aggressive in high beta stocks. Of course there are those who will try to get ahead of the curve, forecast the recovery, and invest early, but it is unclear how they do this, and the more intriguing question is how they expect investors to forecast and time a possible expansion if they were not successful in getting out at any point during the recession. For my money, and that of our clients, we prefer to be highly confident that the recovery is underway and that a major decline is highly unlikely before we make our move. This has proven us well over the past nine years as we have been able to participate in most, if not all, of the upside with little fear of major losses, while also playing defense during major economic and market downturns. This approach has helped us avoid sharp losses twice this decade. So while the market might go up further from here, it is hard to be more then 50% certain it will go up as the current data doesn’t suggest anything more than that the economy is getting worse at a slower rate. Now if you want to read this as the beginning sign of an up-trend I am okay with that but history shows that the markets can decline significantly (10% or more) with economic statistics as they are currently, even if it is not as bad as it was a few months ago. This is not a condition where I would recommend aggressive positions. Although, there are some bright spots and we hold positions in sectors like technology, utilities and health care while we are defensive in major markets tied to the economic growth such as financials, energy and large cap.
So what are the numbers saying? Well, the economy is still losing jobs, hundreds of thousands per month at that. However, the payroll number was not as bad as expected and, believe it or not, the number was not boosted by government payrolls (which actually lost 7,000 jobs). Further good news was that the payroll numbers for last month and the month before were revised up (we didn’t lose as many jobs as we thought) and that is very encouraging.
However, job growth is only one part of the equation and output or economic growth (as measured by GDP) is the other. It still appears the economy will have contracted in the 2nd quarter. That will be four in a row and I have never seen that; so we are off the charts in looking for a bounce-back from negative growth.
Let’s add it all up. We are still losing jobs each month and each quarter, GDP is negative for the unprecedented fourth quarter in a row. The S&P, which has been down for six consecutive quarters, is finally going to have an up quarter, and that is the only real positive sign that is not just a better negative. But, remember, the S&P is still down year-over-year.
This all doesn’t add up to my definition of an expansion. It is a correction in a bear market where the odds are equal that the market can go up from here as down from here and I just don’t like those odds. During expansions and bull markets the odds greatly favor that the market will go up from current levels. The market becomes what I call positively sloped. I love expansions as it takes the guesswork out of investing. Just pick any day to buy and the odds greatly favor higher prices in the future. That is not what we have today. I am not saying that the markets can’t go up or that the end of the recession is not near, what I am saying is that once we can identify the expansion and bull market the risk/reward will be more compelling and the opportunities greater. When that will happen is anyone’s guess, as is whether the markets will be at higher levels than they are now once that occurs. Maybe or even probably yes they will, but really, who cares? It will be lower than when the recession and contraction began and there will be plenty of time and opportunity to make money during the next expansion, so why take on additional risk? The good news is that the entire market will not turn on a dime and that many sectors will turn before the entire economy. In fact, some have already entered a new bull market. This will give a portfolio like ours the ability to participate in the early stages of an expansion without the added risk and volatility of the uncertainty. When the economy started to contract and we became defensive it was late 2007/early 2008. There were many rallies and some economic indicators that looked to be improving but the reality was that the trend was down. While we didn’t know where the top of the market was, we did know that the odds favored lower prices in the future and we were comfortable being defensive at that time. And now, over a year and half later, it’s hard to remember where the price was at the exact start of the contraction. Most likely, a year and half after the next expansion it will be equally as hard to remember where exactly we got aggressive on the buy side, as it will most probably be from lower levels.
So follow the data and invest according to the direction of the economic trend that you can identify today and you won’t be disappointed.
It was this data that alerted us to be defensive as early as December 2007 and indicated that a slowdown was in the offering for 2008, and it will be this data that will signal the all-clear to be aggressive in high beta stocks. Of course there are those who will try to get ahead of the curve, forecast the recovery, and invest early, but it is unclear how they do this, and the more intriguing question is how they expect investors to forecast and time a possible expansion if they were not successful in getting out at any point during the recession. For my money, and that of our clients, we prefer to be highly confident that the recovery is underway and that a major decline is highly unlikely before we make our move. This has proven us well over the past nine years as we have been able to participate in most, if not all, of the upside with little fear of major losses, while also playing defense during major economic and market downturns. This approach has helped us avoid sharp losses twice this decade. So while the market might go up further from here, it is hard to be more then 50% certain it will go up as the current data doesn’t suggest anything more than that the economy is getting worse at a slower rate. Now if you want to read this as the beginning sign of an up-trend I am okay with that but history shows that the markets can decline significantly (10% or more) with economic statistics as they are currently, even if it is not as bad as it was a few months ago. This is not a condition where I would recommend aggressive positions. Although, there are some bright spots and we hold positions in sectors like technology, utilities and health care while we are defensive in major markets tied to the economic growth such as financials, energy and large cap.
So what are the numbers saying? Well, the economy is still losing jobs, hundreds of thousands per month at that. However, the payroll number was not as bad as expected and, believe it or not, the number was not boosted by government payrolls (which actually lost 7,000 jobs). Further good news was that the payroll numbers for last month and the month before were revised up (we didn’t lose as many jobs as we thought) and that is very encouraging.
However, job growth is only one part of the equation and output or economic growth (as measured by GDP) is the other. It still appears the economy will have contracted in the 2nd quarter. That will be four in a row and I have never seen that; so we are off the charts in looking for a bounce-back from negative growth.
Let’s add it all up. We are still losing jobs each month and each quarter, GDP is negative for the unprecedented fourth quarter in a row. The S&P, which has been down for six consecutive quarters, is finally going to have an up quarter, and that is the only real positive sign that is not just a better negative. But, remember, the S&P is still down year-over-year.
This all doesn’t add up to my definition of an expansion. It is a correction in a bear market where the odds are equal that the market can go up from here as down from here and I just don’t like those odds. During expansions and bull markets the odds greatly favor that the market will go up from current levels. The market becomes what I call positively sloped. I love expansions as it takes the guesswork out of investing. Just pick any day to buy and the odds greatly favor higher prices in the future. That is not what we have today. I am not saying that the markets can’t go up or that the end of the recession is not near, what I am saying is that once we can identify the expansion and bull market the risk/reward will be more compelling and the opportunities greater. When that will happen is anyone’s guess, as is whether the markets will be at higher levels than they are now once that occurs. Maybe or even probably yes they will, but really, who cares? It will be lower than when the recession and contraction began and there will be plenty of time and opportunity to make money during the next expansion, so why take on additional risk? The good news is that the entire market will not turn on a dime and that many sectors will turn before the entire economy. In fact, some have already entered a new bull market. This will give a portfolio like ours the ability to participate in the early stages of an expansion without the added risk and volatility of the uncertainty. When the economy started to contract and we became defensive it was late 2007/early 2008. There were many rallies and some economic indicators that looked to be improving but the reality was that the trend was down. While we didn’t know where the top of the market was, we did know that the odds favored lower prices in the future and we were comfortable being defensive at that time. And now, over a year and half later, it’s hard to remember where the price was at the exact start of the contraction. Most likely, a year and half after the next expansion it will be equally as hard to remember where exactly we got aggressive on the buy side, as it will most probably be from lower levels.
So follow the data and invest according to the direction of the economic trend that you can identify today and you won’t be disappointed.
Monday, May 11, 2009
Is the worst already behind us?
Unemployment Friday was an important day at Astor last week, just as it is every month. We review these numbers and aggregate them with other economic data at to get a fresh perspective on what the economy is doing. So what do we see now? Is the worst behind us?
Equities have rallied 30%+ since the lows of March on prospects of a recovery, and that sure feels good. Commodity prices have rallied 22% on the same prospects. However, it is interesting to note that the market is trading at about the same level as late December/early January. The market is still down a good 35% from 2007 levels, and that is after a significant rally the past two months. The US economy has lost over 2 million jobs this year alone and GDP contracted for the highly unusual 3rd quarter in a row. (That has only happened twice before…ever.) Banks appear to still need to raise capital, and while credit spreads have eased, interest rates have moved higher, which will make borrowing more of a challenge, and of great interest is the lack of increase in M levels even after tremendous government stimulus. If they still calculated M3 it would have contracted for the year. The commercial real estate market appears to be another looming problem as firms are unable to restructure debt covenants while losing tenants, and may be a land mine in waiting.
Here is how we see it. That extreme 25% drop in the market this year tells me something. It tells me the amount one needs to pay (the premium if you will) to get cash now. With liquidity virtually gone and credit non existent the only place left to get immediate cash (in two days) was the stock market. With the fear (unfounded I might add) of nationalization of financial related companies, there was nowhere else to turn for cash but to sell stocks. It was true fear and panic. The recovery from those lows has nothing to do with an economic recovery. This has been just a reversion back to where we were before the panic. The only difference is the actual economic statistics have deteriorated since the beginning of the year. Since it is very difficult to equate any current level of the stock market with the current economy, I’d rather just identify the direction of the market and the direction of the economy, and only make a move when it changes.
While the pace of deterioration has slowed recently, this does not mean growth has resumed. The market declines earlier this year reflected poor fundamentals as well as a panic of liquidity. I believe the lows are in. To make "new lows" something new will need to happen and we are watching for that. But that is not enough to say we are heading back to a bull market and economic expansion. It will most likely be a bit of a consolidation from levels somewhere around here plus or minus 10% (more likely minus). I think this is about it for the broad markets.
Time to Change
To that point, we firmly believe the current bounce is an opportunity to rebalance portfolios. For example, when the tech bubble peaked and declined some 70% in 2000-2003, it had a wonderful rally afterwards, but it never fully recovered. The losers did not become the winners during the next expansion. Many companies at the root of the collapse never recovered. That will happen again this time as well.
If you are not utilizing an active management strategy in your portfolio to manage risk and volatility, you must consider this now and stop leaving your portfolio to chance. While it is obviously too late to protect your portfolio against the massive declines of the past 18 months, this rally has created a real opportunity to re-adjust your investment approach.
Astor Asset Management has specialized in this approach since 2001. We utilize the data the economy and market is giving us to tell us how and where to position our clients. We constantly assess the data and our analytical tools to stay ahead of curve. This approach has served us well over the decades as employment trends turned down in 2000 followed by a contraction and bear market and again in late 2007 early 2008. Our flagship L/S Balanced portfolio was down a mere 4.5% in 2008, and as of last Friday, was up over 4.5% for the year and making new profits for clients.
If you’re not using active management now for one reason or another, please click here to visit us online or call us at 800-899-8230. You owe it to yourself to investigate the benefits of a strategy like this to your financial situation. Let us talk you through it. You’ll be glad you did.
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