The headline flashed across my home page (www.wsj.com) on the evening of May 4th: "S&P Up for 2009 As Markets Surge." Who would have thought it back on March 9th, when the S&P 500 Index stood at 676, a level not seen since 1996? Or, as I said to my 13-year old daughter, "the stock market has gone 0-for-your- lifetime." The index started the year at 903, and it was at 1300 as recently as August 28, 2008.
At the beginning of the year, we said to ourselves that it would not surprise us to see the S&P reach 800 AND 1100 this year. We just did not know when and in what order. Well, by mid-February, 800 had already been breached, and while some might call us crazy, the latter figure is not off the table by any means. The market movement of the first 4 ½ months of 2009 has confirmed to us that investors must broaden their expectations for what is possible in the financial markets. This is the legacy of 2008's wild ride.
That is all talk and theory, and it makes for interesting conversation to some of us. However, the real issue is not what is going to happen, but how do we position our portfolios for whatever may happen. Here, we feel we are on much firmer footing than when projecting future market levels.
So, here are two important observations about what 2009's first 1/3 has us thinking about, so far:
1. Keeping losses short-term in nature and shallow in magnitude is more important than anything you do to grow capital in the long-run. This is a central part of our investment approach at Emerald, and using S&P figures from this year, you will see why we think it is so important.
12/31/08 903 3/9/09 676 (loss since 12/31/08 25%)
5/4/09 907 (gain from 3/9/09 = 34%) Year to Date The S&P 500 is about flat.
You may be asking, "why am I not up 9%?" Because taking the brunt of a big market decline impacts you more financially than getting a big share of the rebound. Simply put, if you had $4 and lost $1, you would have $3. If you then made 34% on the $3 that remained, you'd have about $4 again. It is just the math of investment profits and losses, but it reminds us that a 34% gain is less impressive following a 25% loss than it would be otherwise.
The financial impact of sharp declines often pales in comparison to the emotional impact of quickly losing a lot of money. It is even worse when it happens more than once. In his May 11, 2009 weekly market commentary, John Hussman, PhD and founder of Hussman mutual funds describes the investor condition called "revulsion" which is what could result if stocks decline significantly from these levels, after regaining some of the lost ground:
"That cycle of decline, followed by hope, followed by fresh losses, is really what ultimately puts a final low in place. The final decline of a bear market tends to be based on "revulsion" - a growing impatience among investors who conclude that stocks are simply bad investments, that the economy will continue to languish, and that nothing will work to help it recover. Revulsion is not based so much on fear or panic, but instead on despair and disillusionment. In a very real sense, investors abandon stocks at the end of a bear market because stocks have repeatedly proved themselves to be unreliable and disappointing."
As if the ghosts of 2008 were still around in 2009's first quarter, investors fled for the sidelines and the perceived safety of government-backed bonds and CDs. As is often the case in investment history, there are many stories of those who sold out entirely in early March, and stayed "out of the market" through early May. They are now asking their advisors, "should I get back in?" That leads us to observation #2.
2. Investing in an all-or-nothing style is a good way to confuse oneself, all the way to the poorhouse. It is better to have an investment process that finds something productive to invest in during any market environment, and pump the brake or hit the accelerator as needed, without stopping and starting the car over and over.
So, let's conclude with a very valid question asked of me recently by a longtime friend and client. Is the rally since early March a "sucker's rally?" - that is, did some eager investors rush back in, only to realize shortly after that the gains were fleeting?
My answer: you are not a sucker if you grabbed a piece of it, and you are not a sucker if you start to hedge/reduce equity exposure in your portfolio when both the technical and sentiment signals flash caution. We feel like we did so in our portfolios, and by "playing the middle and not the extremes" we can succeed over time regardless of whether this rally continues or fails. As our Technical Analyst Michael Kahn said to us recently, more likely it fails in the near-term. But then it will rise again, perhaps stronger than the previous rally, as we continue the long, arduous transition from bear market to bull market. It's a transition that may take a very long time but present some outstanding ways to make money as it unfolds. There will be many rallies and declines along the way, and thus many suckers born. Hopefully, this issue of GreenThought$ got you thinking about how to avoid being one of them.
The information herein has been obtained from sources believed to be reliable, but Emerald Asset Advisors, LLC ("Emerald") does not warrant its completeness or accuracy. Prices, opinions and estimates reflect Emerald's judgment on the date hereof and are subject to change at any time without notice. Any statements nonfactual in nature constitute current opinions, which are subject to change. Projections are not guaranteed and may vary significantly. Further information on the firm and its advisory fees may be obtained from the firm's Form ADV Part II, which is available without charge upon request. Complete descriptions of all Emerald's products and benchmarks are available upon request.
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