TWO WILD AND CRAZY GUYS
 
     The stock market's spilt personality and what we are doing about it   
 

In our insatiable quest to rekindle pop culture memories of the 1970s and 1980s, we think back to the lovable Czech brothers (played by Dan Akroyd and Steve Martin) from the old Saturday Night Live skit.  The Festrunk brothers, who referred to themselves as "Two Wild and Crazy Guys", proved that when dating in America back in the disco days, a little knowledge was a dangerous thing.  For those of you too young to know what the heck we are talking about, try this link and have a laugh http://www.youtube.com/watch?v=t9SaKYFR6ms&feature=related. 

The stock market has behaved like two wild and crazy guys for most of 2008.  By our calculations (using data from Yahoo! Finance), in 41% of all trading days this year (through August 7th), the S&P 500 Index closed 1% higher or lower than the previous day.
 
SO, WHERE ARE WE?
 
To answer this question, we first have to make an assessment of the environment we are in.  Whether we look at it from a fundamental or technical angle, we reach the same conclusions:
 

• Stocks are in a bear market (meaning: they will be more choppy and volatile, there will be money to be made, but it won't be made as often by buy-and-hold strategies.  But that doesn't mean you day-trade either!).
• Treasury bond rates bottomed last year but the bear market that started (i.e. rising rates) has been on hold for a few months
• Oil and other commodities are suddenly out of favor, but only after a huge run up.  It is quite possible this is a breather, not a top in this market area
   
  

The most common question we get these days is "what should I do in this environment?"  While the specifics are up to the client and advisor working as a team, there are some broad but important guidelines we are following:

1. Be more active, as needed.  Buy-and-hope is not a strategy.
    
   
2. Understand what you own - there are a lot of odd securities out there, in untested forms.  No heroes, please!
    
   
3. Certain segments of the market are experiencing volatility that from a historical perspective is extremely high.  Conservative portfolios should be positioned away from that as much as possible.
    
   

For our Emerald Allocation Strategies (EAS), it has been an unusually active summer, due to the three factors cited above.  To be more specific:

1. We sold some positions that had appreciated nicely since we first bought them, despite a rough market environment over that time frame.   
2. In all three of our strategies, we made a decision to dramatically reduce our use of ETFs that short segments of the stock market, as well as the class of ETF known as Exchange Traded Notes (ETNs).  These securities engage counterparties to create their structures.  Call us chicken, but that counterparty risk, as with auction rate securities, CDOs, etc. is something we'd rather sidestep in today's world.  In place of some of those positions, we have gone back to using actively managed "bear market" stock mutual funds that we used quite a bit back in the days before short-ETFs existed.   
3. In our Global Cycle portfolio, we sold our position in "XYZ" (an ETF that seeks to represent the performance of a specific commodity) after a very large gain over the year since we had first purchased it.  Then in an example of how hedging transactions can function as more than a hedge, we later sold our position in a fund that shorts XYZ stocks.  In other words, over the different time periods we held these two positions, despite the fact that they are somewhat opposite in nature, we profited from both.  It's not magic, just out of the box thinking. 
4. In our Hybrid Strategy, we have seen in recent months how even a modest amount of exposure to commodity-related stocks can have a meaningful impact on Hybrid's volatility.  We don't want that to persist, so we took steps to reduce or eliminate some positions which currently have significant exposure to energy stocks, industrial materials stocks and to a lesser extent, financial sector stocks. 
5. We are currently carrying above-average cash positions in all three strategies, though our research is uncovering some new ideas which we are preparing to introduce in the coming weeks. 

"Wild and Crazy" has been the story so far in 2008.  But by leaning on our conservative nature, and being opportunistic when the risk/reward tradeoff is favorable to us, we believe we can continue to deliver a successful long-term investment experience with only modest bumps along the way.  For partiers like the Festrunk Brothers, that would not be very appealing.  We suspect they would be in the minority these days.
  
The preceding article is not a complete analysis and should not be considered investment advice.  Emerald Asset Advisors, LLC ("Emerald") is a SEC registered investment adviser.  If you would like to receive more information about Emerald, please contact us for a free copy of our disclosure document, Form ADV Part 2 and Schedule F.

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