Beware Chasing Short-Term Performance

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Despite a more than 50% stock market gain from the March 6, 2009 lows, the S&P 500 is still down by about 20% from late August 2008. A rally of that size in approximately five and one-half months is not unprecedented, but it is rare. That such an advance should persist without even a single pullback of 10% makes it even more uncommon. Because the investment industry has become so short-term oriented, the rally has put tremendous pressure on investment managers whose performance is carefully scrutinized at least quarterly. Even those who dislike the fundamental picture are feeling great urgency to add to their equity exposure. Bonuses — even their jobs — may be on the line for managers who underperform their benchmarks in 2009 after having lost money for clients in 2008.

On a fundamental basis, it is clear that U.S. corporate and personal balance sheets have suffered a terrible hit. With unemployment still increasing, the consumer remains under tremendous pressure. Over the past several weeks, however, we have heard repeatedly of “green shoots” suggesting the recession’s end is near. This lends great hope to those who would build a fundamental case for a lasting bull market for stocks.

The technical side of the ledger looks more compelling than does the fundamental. Despite the rally’s scope and duration to date, most technical measures indicate the likelihood of at least somewhat higher prices. The majority of momentum measures are weakening, however, suggesting at least a correction in the not-too-distant future.

In our Second Quarter Commentary (see Prior Quarterly Commentaries) we pointed out that rallies can take on lives of their own and are capable of lasting as long as investor enthusiasm can be sustained. While short covering has been a major ingredient in the rally thus far, each market advance feeds on the additional short covering it promotes. To a point, this is a positive feedback loop, but all such loops exhaust themselves eventually.

Whether or not the market moves higher without at least a meaningful correction, purchasing significant amounts of stock near these levels involves a large degree of speculation. Most measures of valuation are selling above their long-term norms according to Standard & Poors. Because of massive writeoffs over the past year, the price-to-earnings ratio of S&P’s “as reported” earnings is well above 100, a wildly unprecedented level. Following the first quarter of 2010, should S&P’s earnings estimates prove to be accurate, the PE ratio for the S&P 500 will still be over 26 times earnings. Even operating earnings (everything but the bad stuff) show a trailing twelve months PE ratio of 40 today and an above average 17 projected after the March quarter 2010. That’s extremely expensive, particularly in an environment in which the predictability of corporate earnings is highly suspect. Not surprisingly, our investment approach, which seeks only attractively valued stocks with growing earnings, is finding few qualifying candidates at current prices.

Obviously the massive stimulus amounts that have been dumped into world economies have contributed tremendously to the rising levels of world stock prices. What we cannot know today is whether or not improvements in the world’s economies and markets will rekindle the enthusiastic spirit of consumption that has fueled the economic growth of the past two decades. Bulls are counting on a return to our deeply engrained borrow and spend patterns. Bears contend that widespread unemployment and the damage done to consumer balance sheets will alter saving and spending patterns for a generation. The outcome is pure speculation.

Other questions beg to be answered as well. Are global economies and markets performing so well simply because they have been juiced by government induced steroids? Will the effects disappear as soon as the stimulus is withdrawn? Will rescues of major banks and other financial institutions have lasting effects, or will underlying fragility reassert itself once government crutches are removed? Is it possible that world governments and central banks can simply print us out of catastrophe and into prosperity? Or will there be an inevitable day of reckoning? We will explore these and many other questions in future postings.

In conclusion, market prices could certainly continue higher from here. Such an outcome would constitute either successful speculation on market dynamics or a successful resolution of the above-mentioned open questions, answers to which are simply unknowable today. A bet on the positive outcome, however, also introduces risk of potentially substantial loss should some of these questions be resolved negatively.

Those seeking more traditionally defined investment opportunities may want to be more protective of capital in these highly uncertain conditions. Stocks are not cheap, and the current huge advance is essentially uncorrected. It is probable that more attractive buying opportunities will emerge within the next several months, even if markets should head higher first.

Click here  to see how Mission’s Controlled-Risk Flexible Allocation portfolios performed through this extremely dangerous decade. Our strong performance results from a combination of flexible asset allocation as well as a willingness to remain patient when stocks are overvalued and other investors overly enthusiastic.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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The Silliness of 20% Bull and Bear Markets

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This is hardly about a critical investment issue, just one of my market-related pet peeves. 

Last week a headline in the Money section of USA Today proclaimed that the Chinese stock market had nearly entered a bear market, because it had declined by almost 20% from its recent high.  To his credit the author acknowledged that 20% was merely an “unofficial” bear market determinant, as if there were an official definition.  The 20% measure has become so common in recent years that it’s completely understandable that a popular newspaper would use it.  That financial papers and commentators have taken to using the definition regularly shows, at the very least, a lack of thoughtfulness.

The absurdity of using a 20% definition should have been apparent from the market gyrations of late 2008 and early this year.  In the final six months of the market collapse from October 2007 to March 2009, the simplistic 20% measure identified two “bull markets” interspersed among three “bear markets.”  After the 33% decline in September and October 2008, the market skyrocketed by 24% from Friday morning, October 10 to Tuesday morning, October 14.  Voila!  A “bull market” in two market days.  Unfortunately, that dramatic spurt didn’t last, and we suffered another 24% “bear market” over the next five weeks.  But not to worry, another 22% “bull market” to the rescue in the next month and a half before the final “bear market” into the March bottom.  Such a definition of bull or bear markets can make sense only to a statistician.

Perhaps the most obvious refutation of the purely quantitative definition comes from the experience of the greatest stock market collapse in U.S. history.  The U.S. stock market plummeted by 89% in less than three years from 1929 through mid-1932.  It would be difficult to imagine a bull market mixed into such carnage.

After the initial 48% crash in late 1929, the market bounced by a similar 48% in the five months from November 1929 to April 1930.  One could argue that this rally constituted a bull market.  I would prefer to categorize it as a substantial rally in a much longer bear market.  What is far less open to question, however, is the designation applied to four subsequent rallies, ranging from 20% to 35%, in the 15 months from December 1930 to March 1932.  The claim that the market experienced four separate bull markets in just a year and a quarter during the greatest market decline in this country’s history simply makes no sense.

There is no official definition of bull or bear markets.  Logic demands, however, that it include some time factor at the very least.

Are we in a bull or bear market today?  I will leave it to history to define, but I suggest that the market action of the next several months will help clarify that definition.  If the March lows remain intact, it will be clear that we are in a bull market.  Should this rally peak anywhere in the next few months then ultimately decline below the March lows, I would argue that we are now simply experiencing a strong bear market rally, much like the 48% five-month rally in 1929-30.  If the rally lasts well into 2010 yet still fails and prices fall to new lows, we’ll leave the definition open for future argument.



Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Broad Spectrum of Possible Outcomes

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Throughout my 40 years in the investment industry, I have never before seen economic or market conditions present such a broad spectrum of possible outcomes. If all goes well from here, governments and central banks around the world will succeed in reviving economies still reeling from the worst recession since the 1930’s. Residential real estate will stabilize and commercial real estate will be saved from declining into a multi-year funk. Most importantly, consumers will regain confidence and will begin to spend again without fear of a darker tomorrow.

On the other hand, if unemployment persists or accelerates, consumers could remain unwilling to spend for anything but necessities and may depress economic conditions for years to come. The area between these extremes is vast, and there is a great likelihood that we will experience an outcome somewhere within the broad middle of the spectrum.

From past experience we have been conditioned to expect that a recession continues for a few to several quarters, followed inevitably by a resurgence of business conditions which leads us to even brighter economic tomorrows. Anyone who has spent appreciable time in the investment industry knows that it is perilous to one’s reputation to forecast anything significantly outside “normal” boundaries.

Let me run the risk, however, of suggesting that almost anything can happen in the current instance. Be very skeptical of any analyst or investment manager who tells you what is coming in the economy or the investment markets. We are dealing with unprecedented economic conditions, so we have no clear guidelines as to how consumers and the body politic will respond to the unfolding drama. I strongly believe that the critical variable will be the psychological response of global consumers.

Bulls on the economy and the investment markets expect that consumer response to the current recession’s end will resemble that which we have seen over the past few decades. Bears fear that the unprecedented levels of debt built up over the past quarter of a century have set the stage for consumers to emerge from this recession more circumspect with respect to spending versus saving. As leveraged as our U.S. economy remains, any significant consumer slowdown will greatly diminish business profitability and consequently the outlook for our equity markets.

We cannot know how consumers and investors will emerge from this recession. We do know, however, that the vast majority of investors, especially institutional investors, have structured their portfolios based on confidence that market outcomes will resemble those of the most recent several decades. Should the record levels of government stimulus fail to sufficiently offset potentially growing amounts of collapsing debt, we could experience serious economic and market declines that far surpass those anticipated by most investors.

In an environment in which we are incapable of knowing with any realistic degree of certainty how the economic drama will play out, investors are wise to abandon their attachment to fixed asset allocation strategies. Flexible portfolios will be much better positioned to respond to economic conditions that could fluctuate wildly in the years just ahead.

Most investors can tolerate missing a significant portion of a market rally better than they can cope with a substantial loss of investment capital. There will always be more market rallies, but you won’t participate if you have lost your capital. In a highly uncertain environment, investors should do anything necessary to avoid losses that would destroy the portfolio’s ability to meet its objectives.



Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Past Performance May Be Misleading

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The vast majority of investors view past performance as the quality measure of investment managers. Of course, they’ve read the caveat on all performance reports: “Past performance is not necessarily indicative of future results.” Most ignore that completely, especially if a strong track record extends to a decade or more.

Implicit in the confidence born from observing an extended strong track record is the assumption that the manager understood market prospects better than did his/her peers. That manager foresaw what was coming with greater clarity than did other managers. Of course, that assumption could be true in any single instance, but I would argue that it is highly flawed.

Every investment management decision plays itself out over a particular set of future circumstances, a great many of which are unforeseeable in advance. If we had the luxury of viewing a given decision’s result 100 times instead of just one, we would have a far clearer understanding of that manager’s actual foresight. Would that decision prove right 70% of the time or, perhaps, just 30%? Did the manager get lucky this time, despite the probability that the same decision would prove wrong more often than not?

It is critically important for investors to fully understand this as a probability business, not a certainty business. Managers make decisions based on a long list of assumptions. Some will prove correct, some incorrect, largely derived from the psychological reactions of households, businesses and governments. Under either similar or dissimilar circumstances, those entities may react differently leading to a different conclusion.

Investment decisions made in the last dozen or so years have taken place during a unique era in U.S. history. Leverage amounts and equity valuation levels have reached unprecedented heights. These conditions may prove to be long-term precedent or they may provoke “What were we thinking?” reactions in future years. We can’t know, but probabilities would suggest that what appears unsustainable today will not be sustained. In all likelihood, excessive leverage will continue to be unwound, and levels of equity valuation common before the debt bubble era will again prevail.

Investors should evaluate carefully whether investment manager performance earned through the era of runaway debt is likely to be predictive or whether it is the fortuitous result of a phenomenon unlikely to be repeated.

Selecting tomorrow’s best managers is problematic at best. You will strongly elevate your potential for success if the managers you examine explore the full spectrum of possible investment outcomes and structure portfolios fully conscious, not just of the rewards for being right, but of the penalties should the market prove them wrong.



Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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