The ride to disappointment has been very bumpy. First the bubble burst in the 3 years 2000-2002, and from there the stock market clawed its way back so that investors had earned a 3.5% per year return as of October of 2007. We were back even with inflation. But then the next 5 months took all of that back, with the S&P losing 14% from 11/1/07 to 3/31/08.

As painful as the last 5 months have been, we can still learn from this experience. This is the kind of period that serves to stress test our perceptions of what investments are good defensive plays. In the following we review various market segments and strategies, identifying what has worked in the past 5 months and what has not worked.  What sectors, styles, and countries have performed best and worst? Did hedge funds protect? And how about those poor old folks who are retired, and living off their savings?

What doesn’t kill you makes you stronger

As the following two exhibits show, there was no place to hide in the long-only equity markets. Every sector, style and country lost money, and there were substantial spreads between the best and worst performers / losers. On the style front, large core defended best, losing only 6%, compared to the hemorrhage that crippled small growth companies, losing 26% -- a spread of 2,000 basis points. Our definition of “Core” is the stuff in the middle, between value and growth. Our style definitions are mutually exclusive and exhaustive, making them excellent for style analyses, both returns-based and holdings-based. We use Surz Styles and Countries throughout this commentary, as described at  Surz Styles.

On the sector front, Consumer Staples almost broke even, losing only 0.4%, while both Financial and Information Technology stocks lost 22%, again a very large 2,200 basis point spread. It’s interesting to note that Consumer Discretionary stocks were also hard hit, presumably because the credit crisis portends decreased discretionary spending. Also of interest is the relative resilience of Chindia stocks, namely Energy, Materials and Industrials. While you couldn’t hide, you could alleviate some of the pain.

Fleeing the country didn’t help either. As the next exhibit shows, Latin America was your best hope, but even that relatively hot region lost 7%, about the same as large cap domestic core. The overall foreign market was down 12%, losing somewhat less than the 14% decline in the U.S. EAFE, on the other hand, lost the same 14% as the U.S. The worst performing region was Asia ex Japan, which includes China. This had been the best performing region for several years prior to this correction.

Make lemonade when the market gives you lemons: Winning the Losers Game

This is one of those unfortunate times when consultants and investment managers will try to console their clients by explaining how their pain is less, hopefully, than most others. This will be awkward and delicate, and is likely to bring forth the difficult questions about bailing or doubling down. As for good relative performance, we’ll need to look back two years or more to find a timeframe where positive returns are winners. As the following exhibit shows, a 10% loss will win the performance race for those who are benchmarked against the S&P500, because a -10% return ranks in the top quartile for the two quarters ending 3/31/08. “Congratulations Mrs. Client your manager performed very well, losing “only” 10% of your account in the past 6 months.” The universes in this exhibit are created using an unbiased scientific approach described at PODS . They represent all of the possible portfolios that managers could have held when selecting stocks from the S&P500. Traditional peer groups are very poor barometers of success or failure because of their myriad biases. Everyone knows that it’s easy to find a peer group provider that makes you look good, but for some reason the industry tolerates, even condones, this deceptive practice.

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