Since October 3, the market has unwound much of the damage done in July through September as markets have recognized Europe’s progress on stemming systemic default risk and the improving likelihood that the U.S. will avoid a double dip recession. Markets lead expectations. When most market participants woke up to negative trends, the market was already down and when most of us wake up to better news, the market is already up. That is the definition of a leading indicator.

We encourage long term investing for long term goals. Only have money in the stock market you don’t plan to spend in the next 5-7 years or more. While we don’t know what will necessarily happen in the shorter term, we know that stocks provide the best returns available over the longer term. We rebalance opportunistically, buying the dips and selling the rally’s, when individual positions get out of balance by more than 10-20%.This forces a buy low, sell high process which ads value over time.

Please call the office with your questions or concerns.

•  Economic and corporate indicators continue to point to modest economic growth. Leading economic indicators rose again in August. Prices are undervalued.
• Markets discount a Greece default on its debt obligations. Concern of “contagion” is a major cause of U.S. equity declines. However, Greece appears dedicated to not letting this happen. If it does, markets will be chaotic for a spell and likely create a further buying opportunity.
• Consumer sentiment is very poor. While this could induce the first ever confidence led recession, odds are it is setting the stage for capitulation and a rebound.
• A recession is priced into the equity markets yet the odds of a renewed recession are only 25%-30%. This is bullish.
• Market trends are decidedly down, but selling during a market decline has not proven to be a winning strategy. Markets always eventually rebound and they can turn very fast, often when things look bleakest.
• The best course of action is to maintain liquidity for spending purposes and rebalance portfolios, buying equities to take advantage of the market pullback.

On July 29^th, the Bureau of Economic Analysis released its initial estimate for the 2^nd quarter “real” GDP growth (Gross Domestic Product) of a weak 1.3%. More notably, the BEA revised downward 1^st quarter growth from an already weak 1.9% to a paltry 0.4%. What this means is the economy is growing very slowly and not enough to create jobs in any meaningful way. The BEA also revised downward GDP growth data from 2003, which of course included the “great recession” of 2008-2009. The 4^th quarter, 2008 contraction was changed from -6.8% to -8.9% and the 1^st quarter, 2009 was lowered from -4.9% to -6.7%. The cumulative decline from the 4^th quarter 2007 peak to the 2^nd quarter 2009 trough in real GDP was revised downward almost 50 basis points (0.5%) to -5.1%. These are huge negative revisions and indicative of how severe this recession was, and how far we have to climb to get back to where we were.  

Then on August 1, the Institute of Supply Management released its July manufacturing report, which showed growth in manufacturing, but at a slower pace then June and below expectations. The question in my mind is how much of this slowdown was caused by Congressional inaction on the debt ceiling debate. When consumers are uncertain about the future, they hold on to their cash and quit spending.

As well, the drum beat of potential further European Union credit defaults continues. The European Central Bank is in talks with Italy, Spain and others in efforts to contain the potential for Greece like defaults. While this could clearly get messier, systemic failure of the banking system seems highly unlikely.

Global economic activity throughout most of the first decade of the 21^st century was helped in no small measure by easy credit and overuse of leverage, by both the consumer and world governments. This is now unwinding. Asset bubbles have burst and easy credit is gone. This process will not be rushed. We cannot push on a string.

 Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and formerly chief economist at the IMF has written an excellent article that reframes the issues of the day. He suggests that rather than having come through a Great Recession, we are going through the second Great Contraction. This makes complete sense to me. See the article here: http://www.project-syndicate.org/commentary/rogoff83/English.

The consumer is now retrenching. Savings and debt reduction is in vogue more so than over spending. We hope this continues as it is very bullish for the economy longer term. For its part, the Federal Government is now talking about actual deficit reductions. The debt deal earlier this week is hardly a down payment on what must be more substantive talks on our Government, and its people, living within its means.  

The market is a discounting mechanism so responds to changes in expectations. You are seeing this up close and personal this week. Adjustments happen quickly to reflect the new information. The best guess of the “appropriate” market levels that reflect all the positives and negatives of the day, are the current prices. That is today, tomorrow and every day hence. Regardless of the current dislocations in the economy and in the markets, investors are well served by adhering to their strategic asset allocations while maintaining cash for this year’s spending needs. We will rebalance portfolios when appropriate to buy the underweighted asset class and sell the over-weighted asset class. Without fail, markets always resolve corrections to the upside….sometimes quickly….sometimes slowly….but always. Today’s employment release was a fundamental step in the right direction, but the market is not quite ready to agree…yet.

We are cognizant of human behavior and recognize that people get concerned when their nest eggs are rattled. But markets regularly correct and then once again move higher. I’m sure we are all suffering from some PTSD from the 2008-2009 “Great Contraction”. However, there is nothing remotely similar to the current situation and that series of events.  

While currently the market is focused on the slow down in the economy and the potential for European contageon, there are several reasons to be optimistic. Corporate earnings are strong; oil is down 10% from its recent high; there are no major dislocations in credit markets; inflation is benign; interest rates are low; consumers are saving (allowing for future investment); Congress is serious about reducing our deficits; equity valuations are quite compelling; fear is running high (a contrary indicator); and the market is already down 11% since July 22.

We are available for questions, to provide additional commentary or to hear your concerns.

I received an MBA in finance in 1986 and started my investment career that year. As such, I have been in the investment business for about 25 years and counting. As a student, I learned about efficient markets and the cons of trying to outsmart or outguess the market, but then I was hired as a securities analyst and was paid for my opinion. In the bull market years of the 1990’s, we picked winning stocks with impunity. Interestingly enough, it got a lot harder to pick winners in the early 2000’s. Looking back, I see that the market’s underlying direction had a lot to do with our perceived skill or lack thereof, rather than much in the way of unique insights.

These last nine years, I have been managing portfolios for individuals and small company profit sharing plans. I have worked hard to add value by moving securities around the asset allocation board, either to generate incremental returns or in an effort to mitigate loss. Sometimes moving around helped, but other times it didn’t. As a Registered Investment Advisor, I owe my client’s a fiduciary responsibility to act in their best interest. Last year I decided it was time to review the body of evidence and refresh my opinion on the age old debate between Market Efficiency and Market Timing. While the debate rages on, the data indicates there is no debate.

The body of evidence strongly suggests that markets very quickly discount new information and which way the market is going to go next depends on the next piece of information, and so on and so on. Guessing which way the market is going to go next is well, guesswork. We can only know whether or not we should respond to this current 5.5% pullback by buying or selling with hindsight as a guide. Undoubtedly some market “professional” will guess correctly that person will be paraded out on all the talk show to tout their market prowess, until the next prognosticator comes along. But they in all likelihood just got lucky. Statistically, it takes 63 years to separate skill from luck at the 95^th percentile.

Surely, some people are sharp enough to add value over a “buy and hold” strategy, but the key is to add value net of fees, transaction costs and taxes. Many peer reviewed studies show that “time in the market” actually outperforms “timing the market”, net of costs. The only observation that is statistically noteworthy (using multi-linear regression for you geeks out there) is that over the longer term (1927-2010) the stock market outperforms the Treasury bond market by about 8.0% per year, on average. Beyond that, small capitalization stocks outperform large capitalization stocks by an average of 3.75% per year and value (low price to book) stocks outperform growth (high price to book) stocks by an average of 4.9% per year. This phenomenon has persisted over all 20 year periods and over the vast majority of 10 year periods.

Beyond these investment “risk factors”, there is NO statistical evidence that professionals, much less average investors add value by moving pieces around the board. In numerous academic studies, no more top decile performers in any 3, 5 or 10 year periods were again top decile performers in subsequent 3, 5 or 10 year periods than would be expected by pure chance.

The reason professional money managers continue to try to beat the market in spite of all the evidence that it is a loser’s game boils down to one reason and one reason only. They are paid to play the game by individual and institutional investors. Hope springs eternal. Wouldn’t it be great to pick the winners and avoid the losers. It is everyone’s greatest hope. It has surely been mine. However, honest reflection begs to differ.

What we know with certainty is that fees, transaction costs and taxes are drags on performance. Rather than view the market as an enemy to conquer, the smart money says we should view the market as a friend, to be embraced and ridden for all it is worth. Establish your strategic asset allocation that is consistent with your goals, time horizon and ability to sleep at night. Invest based on your personal goals. That is, based on when you expect to spend the money: Long term investing for long term needs. When markets invariably tumble and your allocation percentages stray, rebalance and buy more of the asset classes that have fallen. When the market invariably recovers (and it always does), rebalance and sell the asset classes that rose.

Leave the market timing to those that don’t need their money. You’ve worked too hard for yours.

Price rises have to be broad based before inflation becomes persistent. When just one or two items in a basket rise, consumers tend to trade off one purchase for another. That is, they will tend to buy gas and drive less, or spend more on food stuffs, but eat out less often. Relative price changes are not general inflation. General inflation occurs when expected price changes get passed along into higher wages, such as occurred in the early 1980’s. With high unemployment, excess capacity and cheap wages overseas, general inflation is unlikely.

GDP growth for Q1 is likely in the 2% level, down from earlier expectations of around 4%. A long winter, harsh storms, Middle East and Northern Africa tensions, the potential shutdown of the government, and the Japan earthquake/tsunami/nuclear meltdown have all worked to lower consumer confidence and thus output. However, with an improving jobs outlook, a moderation of world tensions, lenders supporting durable goods purchases (cars, appliances, etc), and progress on the deficit, confidence is expected to rebound into the back half of the year and beyond.

Mr. Lockhart argued that the Federal Reserve has been very clear that Quantitative Easing II is set to wind down by June 30 and the bar is set very high for a QE3. He observes that markets tend to be disrupted by unforeseen events, not expected events and that the end of QE2 has been telegraphed and is expected.

On other topics, Mr. Lockhart observes that the weak U.S. dollar has helped exports and U.S. manufacturing. Home prices continue remain the weak link and are being watched carefully.

Typically, things look bad when markets decline and I have found it difficult at best for investors to buy when things look bad. Of course, that is exactly what one should do. Even so, if you had a 60% probability of being right on the call to get out and a 60% probability of being right on the decision to get back in, there is only a 36% chance of getting both decisions right (60% x 60%). It was this problem of back to back correct decisions along with the negative drag from transaction costs and taxes that has caused me to forgo tactical asset allocation and rather use the market to my advantage rather than attempt to use it as my adversary. The stock market rises about 10% per year on average, but tends to do that in fits and starts, rising, then falling, then rising. The best course of action is to rebalance portfolios when holdings move beyond a certain band, say 10% or 20% from the strategic allocation. That way, one is forced to buy low and sell high.

My client did not need most his money to live on for several years, so he had decided to stay put. Of course, he was saying “I told you so” earlier this month when the tensions in the Middle East and the earthquake/tsunami/nuclear meltdown in Japan caused a rapid decline mid March. From February 18 (the recent market high) through March 16, the S&P 500 fell 5.4%. However, it then immediately turned around and now sits right where it was in mid February. Nothing much as improved except we see that the world is not falling apart, at least not yet, but the market has recovered. Focus on the long term results, not on the shorter term drama of the day. Focusing on short term drama is a great tool when you are driving, but not when you are investing.

No one knows how much or what effect the earthquake/tsunami/nuclear meltdown/radiation leak will have on the global economy, but hedge funds and market traders are acting in typical fashion with their “ready, shoot, aim” mentality. What we do know is that markets react to sudden exogenous shocks and then always come back. This bears repeating. There has never been an event that caused the market to decline where time, talent and resources hasn’t healed the event’s wounds, causing the market to ultimately work its way back higher. World War One and Two, the Chernobyl disaster and 9/11 are notable examples. Even man made disasters such as the Tech Bubble and most recently the 2008 financial melt down have “resolved to the upside.”

This is not to say the pain and damage from the current disaster is over. But guessing how far and how fast a market will correct in the heat of the emotional moment is always difficult. What we do know is that longer term, the world will survive and adjust and expand and grow again, pulling the market kicking and screaming along for the bumpy ride. Average stock market returns are in the 10% per year range in spite of the issues that plague our globe with resounding regularity. These issues cause volatility, but it is this volatility that makes the 10% average return feasible. Lower risk would cause lower return.

We believe the best course of action for long term investing is to use periods of temporary decline to rebalance portfolios and buy the declining asset class on weakness. This forces a buy low mentality. Investors should always have enough cash available for current needs and enough fixed income for 5-7 years of spending needs. Longer term spending goals beyond 8 years or so can (and depending on your risk tolerance likely should) be in longer term assets such as equities. Younger clients with years until retirement have no retirement account spending needs.

We will maintain vigilance and are regularly reviewing asset allocations. Portfolios are conservatively managed and are well diversified. Please give us a call to discuss your specific situation and concerns and let us answer any questions you may have.

Integration occurs when your core believes and highest goals become the reference point for financial and life decisions. Uncovering your core beliefs and highest goals requires a well developed “Discovery” process. Last week I attended Kingdom Advisors annual conference in Orlando, FL. Kingdom Advisors is a faith based association which advocates operating one’s financial advisory practice on Biblical principles. In one of the sessions, they discussed a model of the different roles of the advisor and I wanted to share that with you today.

An Integrated Wealth Planner fills at least three roles for clients: Leader, Advisor and Coach. My role as Leader is to provide inspiration and direction towards better financial and spiritual health. My role as Advisor is to provide technical advice along with an understanding of how best to implement that advise relative to your aspirations and goals. Most of traditional financial planning and asset management services reside here. As Coach, my role is to remove barriers to growth and change by engaging clients in meaningful dialogue. The integration of any two of the roles blends the expertise accordingly. The integration of all three roles will help you define and establish your worldview and how best to facilitate narrowing the gap between your ideal self and your actual self.   

Enjoy your President’s Day

The Gap is the space between our Ideal selves and our Actual selves. Our “Actual selves” are our actual achievements and results in life. It’s what we actually get done. Our “Ideal selves” is who we are after we accomplish our long list of goals and desires. It is a mental construct that helps us set goals, dream about the future and motivate us towards our goal accomplishments. 

Unfortunately, Ideals exist only in our minds. The ideal is rarely if ever actually achieved. As such, how we manage the Gap, or our perspective, directly influences our level of happiness. If we always measure our Actual results against our Ideals, we will fall short and we can become frustrated and even despondent. That is seeing the glass as half empty. However, if we measure our results against where we started, we will see how far we have come and be more likely to be pleased with the progress. We will see the glass as half full. 

Let’s call where we started as Actual 1 and where we are now Actual 2. Measuring our achievements from Actual 1 to Actual 2 is quite productive. Realizing we have more progress to make is also useful; that is, the distance between Actual 2 and the Ideal. But remember, we are unlikely to ever get to Ideal. We will set new goals, change our plans or whatever. Ideal is always in the distance.  

I know many individuals that are very successful, but they are not particularly happy because they always fall short of their Ideal selves. They don’t give themselves credit for the ample progress they’ve made over time. I encourage them and you to reframe your perspective and see the progress you’ve made. You will be much happier if you do.

Fixed income produced reasonable returns as well with the Barclays Intermediate Term Credit Bond index returning 7.6% for the year. While not nearly as volatile, but in contrast to equities, fixed income was down each of the last two months, shaving a combined 2% from total year returns.

If this increased volatility continues, which we believe is likely, opportunistic rebalancing will take on additional importance to capture the incremental returns that the market is offering. At present, we have our rebalancing software set to alert us to a rebalance opportunity if a particular asset gets more than 10% out of balance. This forces a “buy on weakness, sell on strength” discipline. For example, if the strategic allocation to large cap equities were 20%, we would be alerted to a rebalance opportunity if the allocation moved above 22% or below 18%.

This rebalancing strategy will work as long as pullbacks don’t turn into real routs. If this occurs, it is good and appropriate to have a backup plan such as using moving averages to help assess “stop loss” points on an asset class by asset class basis. This forces a culling of laggards. We lowered positions in Developed International and in Healthcare during the year based on these conditions, both to good effect. Developed International rose 6.7%, about ½ the domestic US return, on Sovereign Debt issues, while the Healthcare sector rose a modest 2.4% on uncertainty surrounding Healthcare Reform.

The markets are responding well to the Federal Reserve efforts of monetary easing, improved GDP growth, modestly lower unemployment and low core inflation pressures. While things can obviously change, for now, it is steady as we go.