Chasing Performance

The end of 2008 is almost here.  For many investors that will be a welcoming event.  I think it's safe to say that most investors will be more than happy to put this year behind us.  

However, this reminds me of something else that is about to happen.  In January, you will start to see the "Best of 2008" lists.  These are the lists that rank the top performing stocks, ETFs, and mutual funds for 2008.  This happens every year.  Investors see these lists in Money, Fortune, SmartMoney, The Wall Street Journal, The USA Today, and so on.  

Mutual fund investors will often compare these top performers with their own mutual fund holdings and get frustrated.  Acting out of emotion, they will sell their current holdings and "chase" performance by buying the funds on the "top performers" list.  Usually, this is a HUGE mistake.  Here's why: More often than not, today's winners will be tomorrow's losers.  

Here is a case in point: Legg Mason Value Trust (LMVTX).  This fund's manager, Bill Miller, spent nearly two decades building a reputation as one of the greatest mutual fund managers ever.  He consistently outperformed the S&P 500 year after year.  Then, in one year, his track record took a major hit.  Here is an excerpt from an article in yesterday's Wall Street Journal profiling the fund's fall from glory:

A year ago, his Value Trust fund had $16.5 billion under management. Now, after losses and redemptions, it has assets of $4.3 billion, according to Morningstar Inc. Value Trust's investors have lost 58% of their money over the past year, 20 percentage points worse than the decline on the Standard & Poor's 500 stock index.

These losses have wiped away Value Trust's years of market-beating performance. The fund is now among the worst-performing in its class for the last one-, three-, five- and 10-year periods, according to Morningstar.

Here are a few lessons learned from this example:

1. Just because a fund has consistently been a top performer in the past doesn't mean it will always be a top performer in the future.
2. Every great money manager will have a period of underperformance.
3. Investor's who "chased" performance by buying the fund anytime in the past 10 years now have a loss.

There is much more to mutual fund selection than last year's performance.  In addition to performance, there are 3 other P's you must understand about a mutual fund:

• Philosophy - How does the manager approach investing?  Try to understand exactly what the manager is looking for in an investment.   Spend as much time as you can seeking to understand the manager's investment criteria. 
• Process - How does the manager execute his or her philosophy.  What are the steps the manager takes to narrow down the vast universe of investment opportunities?  How does the manager identify the most attractive investments to be included in the fund portfolio?
• People - What is the manager's experience and prior track record?  What is the quality of the research team that supports the manager?

10 Things I'm Thankful For

I love Thanksgiving.  I love the food, and I love the time with family and friends.  But, I also love the spirit behind the day...an attitude of gratitude.  

You see, with all the negative news about the economy and stock market it's easy to forget the good things in life.  It's not intentional.  It's just that the negatives in life seem to build this cloud over all the positives not allowing us to see life with a clear perspective. 

However, when you take the time to step back and think about it...life isn't so bad.  In fact, if you are living in the United States of America you have a lot to be thankful for even when the economy is in a recession and the stock market is struggling.

I have A LOT to be thankful for.  Here are just 10 things that come to mind:

1. Family & Friends.  I have a great family and many wonderful friends!  No explanation needed.  Everyone knows what a blessing it is to have family and friends.
2. Living in the USA.  Yes, today our economy is in a recession.  Since 1926, we have been through 14 recessions.  In all cases, the economy eventually recovered and the stock market went on to reach new highs.  Our country is resilient.  Freedom, opportunity, and determination have enabled Americans to make our world a better place.  I'm glad I get to be part of that.
3. An opportunity to buy stocks at cheap prices.  The recent crash in the stock market has created an opportunity to buy stocks at levels rarely seen in an investor's lifetime.  If you're investing for a goal 10 years or more from now, then you don't want to miss this opportunity.  I see some high quality businesses with strong finances where the stock is now trading at value prices. 
4. Our firm's new investment strategy, the Global Trends Strategy.  This strategy is designed to participate in rising trends and be on the sidelines when there are none.  The strategy is working!  
5. Dividends.  When investing in individual stocks we prefer to invest in companies that pay dividends.  Dividends are especially nice when stock prices are declining.  We have retired clients who are living off their dividends.  Although the drop in price for the stocks they own is no fun to watch, it's the dividends that keep them invested.  Without dividend income what would they live on?
6. Technology & the Internet.  I recently moved to South Carolina.  Technology has enabled me to continue to work seamlessly with the team in Ohio and stay in touch with our clients.
7. Clients.  I wouldn't have the opportunity to do what I love without our clients.  Our firm has many loyal clients who have placed their trust and confidence in us.  I am honored to work for every one of them.
8. The team of people I get to work with.  They are fun to be around and great at what they do.
9. The invitation from some new friends to join them at the Clemson vs. South Carolina football game this Saturday.  Go Tigers!
10. Did I mention family and friends?

I could certainly go on all day about the things I'm grateful for.  How about you?  Do you have an appreciation for the good in life, or are you stuck on all the things that aren't perfect?  There is no better time than now to re-focus your perspective on life.  Refuse to participate in all the "Oh, no! We are in a recession, and we are headed for The Great Depression 2.0!" talk.

Happy Thanksgiving!

The Strategy Works

On July 1, 2008 our firm launched a new investment strategy, the Global Trends Strategy.  The investment approach is simple:

1. Identify sustainable trends.
2. Invest in those trends via ETFs.
3. Adapt quickly when those trends change.
4. When unable to identify a sustainable trend, wait in cash.

The strategy is designed to participate in rising trends and be on the sidelines when there are none.  The strategy is working!  On September 18th the portfolio was 90% in cash.  The Dow closed at 11020 that day.  By October 16th the portfolio was 100% cash and has been ever since.  As I write this the Dow is now trading around 8500.  In other words, the market is now 23% BELOW the level at which we began selling our positions.  Our risk management rules told us it was time to be in cash.  The decision to be in cash has protected us from the painful crash in the market as well as "the worst week ever".

On October 3rd (with the Dow at 10325) I wrote "Cash Is King...For Now".  My main point with that post:

If you've been executing a trend following strategy, then by now you should be in cash and you should stay in cash until new trends are established. 

Cash is still king for trend followers that are looking for sustainable rising trends.

[DISCLOSURE: Clients of Freedom Financial Solutions, LLC that are invested in the Global Trends Strategy currently have a cash position of 100%.]

Understanding the Financial Crisis in Less Than 3 Minutes

Here is a nice video via Enspire Learning that provides an explanation for the financial crisis:



Obviously, it is more complicated than a 2 minute and 17 second video can explain. However, the video is well-done and tackles the root of the problem.

I like short and simple explanations like this. How about you? Have you found videos or visuals that explain the current financial crisis in short, simple, and easy to understand terms? If so, feel free to post your links in the comments to this post.

New Stock Market Terms

Some Friday afternoon fun originally posted by Barry Ritholtz at The Big Picture:

A fun email circulating trading desks, worthwhile as an informal measure of sentiment:

CEO -- Chief Embezzlement Officer.

CFO -- Corporate Fraud Officer.

BULL MARKET -- A random market movement causing an investor to mistake himself for a financial genius.

BEAR MARKET -- A 6 to 18 month period when the kids get no allowance, the wife gets no jewelry, and the husband gets no sex.

VALUE INVESTING -- The art of buying low and selling lower.

P/E RATIO -- The percentage of investors wetting their pants as the market keeps crashing.

BROKER -- What my broker has made me.

STANDARD & POOR -- Your life in a nutshell.

STOCK ANALYST -- Idiot who just downgraded your stock.

STOCK SPLIT -- When your ex-wife and her lawyer split your assets equally between themselves.

FINANCIAL PLANNER -- A guy whose phone has been disconnected.

MARKET CORRECTION -- The day after you buy stocks.

CASH FLOW -- The movement your money makes as it disappears down the toilet.

YAHOO -- What you yell after selling it to some poor sucker for $240 per share.

WINDOWS -- What you jump out of when you're the sucker who bought Yahoo @ $240 per share.

INSTITUTIONAL INVESTOR -- Past year investor who's now locked up in a nuthouse.

PROFIT -- An archaic word no longer in use.

The Worst Week Ever

Last week was the worst week ever in the U.S. stock market. For the week, the S&P 500 and the Dow both crashed -18.20%! I survived! If you are reading this, then chances are...you survived too!

The Facts

Let's review what just happened:

• Last Friday, stocks endured the widest intraday swing on record. For the first time ever, the Dow traded in a range of more than 1,000 points in a single day.
• Trading activity hit new records on Friday. The New York Stock Exchange composite volume hit 11.6 billion shares, a new record. Nasdaq trading also hit a record, as 4.18 billion shares changed hands.
• For the week, the Dow dropped 1,874.19 points, or 18.2%. This was the worst week in its 112-year history.
• The Dow closed the week at 8451.19, the lowest finish since April 25, 2003.
• Stocks indexes have closed down 8 days in a row.
• Stock market losses (in the DJ Wilshire 5000 Index) now total $8.4 trillion since the market peak one year ago.
• The Dow is now down 40% from its October, 2007 peak.
• The VIX, a measure of fear based on options trading, rose to 69.95, its highest level since it was introduced over 15 years ago.

Sources: Wall Street Journal, Investors Business Daily

How Did This Happen?

Do you wonder how we got here? Read this article which appeared in the New York Times on September 30, 1999. Here are a few highlights from the article:

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

From about 1998 to 2006 home prices grew at an 8% annualized rate (source: Robert Shiller). Many in America began to operate under the assumption that house prices would always go up. Well, as we found out, that's not true. The housing bubble popped! As the housing market has declined, over leveraged families and banks holding assets related to home mortgages have suffered significant losses. As a result of these losses, many banks lack the capital or the confidence in each other to make new loans. This has now led to frozen credit markets.

The bottom-line is that massive leverage is what got us here. The problems resulting from years of growth in the amount of debt relative to the size of the overall economy has now infected the global financial system. Financial institutions, hedge funds, and households are being forced to reduce debt (deleverage) all at the same time. This results in forced sales because as asset values start to decline, leveraged investors must raise more capital. To do so, they sell what they can putting more downward pressure on asset prices. Another consequence this has created is a lack of capital in the banking system.

What's The Solution?

At the moment, credit is essentially frozen and a world-wide recession seems almost inevitable. However, we won't have a 1930s style depression if we look forward and tackle this crisis head-on. The solution to the present crisis will involve substantial deleveraging and a recapitalization of our financial institutions.

Beyond the immediate problem, we need to see a bottom in housing prices. A key problem in the housing market is inventory: The supply of homes simply exceeds demand. And as a result, home values have declined. Once supply and demand balance out, our housing market will be able to recover, and that will help our broader economy begin to grow.

Finally, we will need lots of patience as it will take some time to fix these problems. Will this process be easy? No! But, can we fix it? Yes!

Let's Get Bullish On America: Remember...It's AmeriCAN, not AmeriCAN'T

Turn on the TV or read the newspaper and you are overwhelmed with negativity and a sense of panic. Sentiment is terrible and satisfaction is at an all-time low. According to CNNMoney.com, 60% of Americans think a depression is likely. Time magazine's latest issue has a picture of a soup line from the Great Depression era on the cover. You know there's panic when Jim Cramer says its time to get out of the stock market. There's even a new blog out: Sad Guys on Trading Floors. I agree with Barry's thoughts on this new blog: "Its funny and sad and poignant, but for our purposes, its a yet another in a list of contrary indicators that suggests things are getting overdone, and that sentiment is moving towards an extreme. A blog such as this could only be conceived of during times of extreme market stress."

We must change the mood in America. Without a doubt these are extraordinary times, and America is facing a crisis. Let's respond with optimism! I am bullish on America, and you should be do. We have faced times of crisis and uncertainty before and we've not only survived, but we've thrived.

To get you started thinking more positively take a look at Barry Ritholtz's recent post: 10 Bullish Charts, Signals, Indicators.

What To Do Now?

We don't have any evidence yet that we have hit a bottom in the stock market. However, with the Dow now down 40% from its peak we should be getting close. It is certainly possible for this market to go lower and trends often last longer than you expect. However, the best opportunities in the history of the stock market came during periods of crisis and panic. As Warren Buffet has said, "good investors are fearful when everyone else is greedy, and greedy when everyone else is fearful.”

Just because the stock markets have panicked doesn't mean you should. Now is not the time to abandon your investment strategy. You do have a strategy, right? If not, now is the time to develop one. Some great opportunities lie somewhere ahead. Crisis creates opportunity. This crisis is in the process of creating some "once in a lifetime opportunities." You won't want to miss out. Don't quit now. If you do, you will regret it.

If you are young and stashing money away on a regular basis, then stay the course. If you are approaching or are in retirement, then now is not the time to decide to get more conservative with your asset allocation or investment strategy. Don't let an emotionally driven decision destroy your retirement prospects.

Don't fall into panic mode as many others already have. To succeed you will need to be 1.) PATIENT, 2.) DISCIPLINED, and 3.) CONFIDENT.

Are you overwhelmed by "the worst week ever"? Are you unsure of how you should respond to the current crisis? Have you wandered if your investment strategy is sound? Maybe you're just tired of managing your own money? Or, do you find that there's simply not enough time or desire to do the work? If you have $100,000 or more of investable assets, then I can help! My firm can manage your money for you. Contact us to see how we might be able to help you.

Cash is King...For Now!

Fear has spread throughout Wall Street and Main Street. One consequence of all the fear on the Street is the lack of sustainable positive trends.

As the heading on this blog states I believe that "There's always a bull market somewhere!" In other words, I believe that at any point in time there is always a broad market index, a sector, an industry group, a country, an asset class, a commodity, or a currency that is in a rising trend. For instance, the first six months of this year stocks in the U.S. and across the globe were down. However, the price of oil was up, commodity prices were up, and precious metals were up. You could have generated some nice returns during the first half of 2008 by avoiding stocks and investing in USO (oil), GSG (commodities), GLD (gold), and SLV (silver). However, in July the trends in all of those asset classes turned bearish. Trend followers would have exited those positions only to find a lack of sustainable trends elsewhere.

The third quarter of 2008 was marked by fear and panic as the credit crisis and collapse of financial institutions roiled the markets with uncertainty. But remember, fear and panic is what it will take to establish a bear market bottom that lasts. Everyone would like to know where the bottom of this market is or how long the bear market will last. The answer is: no one knows. Changes in market trends and the duration of those trends can not be predicted in advance. As a trend follower, all I can do is identify current trends and follow them. What I do know is this: CASH IS KING...FOR NOW!

Here are a few trend following principles to keep in mind:

1. Don't fight momentum; embrace it! Trends often last longer than people expect. It is more likely that a trend will continue rather than reverse. The path of least resistance is most often the current path of the trend. Always assume a trend will continue until you have proof (from charts and technical analysis) that it has reversed.
2. Trends reverse quickly. Just review the charts for the ETFs I mentioned above. You will see that although they were all in rising trends during the first half of this year, they all reversed sharply in July and August. The trend is your friend...until it isn't! You must have an exit strategy. Know your sell rules and follow them.

With those principles in mind it's important to remember that the current trend for almost everything is DOWN. Until there is more certainty related to the credit crisis and problems in the banking industry, don't fight the downside momentum. If you've been executing a trend following strategy, then by now you should be in cash and you should stay in cash until new trends are established.

[DISCLOSURE: Clients of Freedom Financial Solutions, LLC that are invested in the Global Trends Strategy currently have a cash position that ranges from 90% to 100%.]