(text of email sent 2/11/09)
The stresses on the economy and on the capital markets — about which we have been communicating with you regularly over the past several months — continue. In this bulletin, we want to offer some additional perspective on the current state of affairs, provide a review of the actions we have taken and intend to take with respect to your portfolio, and explain the overall strategy guiding those actions.
The economy continues to deliver bad news daily. The silver lining to this is that much of the bad news lately is related to unemployment. Why is that a silver lining? Two reasons. First, unemployment has historically been a lagging indicator of the economy; in past recessions, unemployment typically peaked at its worst level when the economy had already begun its recovery. Second, the equity markets have typically been a leading indicator of the economy. Those two phenomena, taken together, result in the fact that, over all the recessions in the last 50 years, stocks began their recovery, on average, nine months before unemployment peaked. In other words, stocks started increasing while unemployment was still getting worse. Could this time be different? Perhaps. Is betting that this time is different a prudent strategy? We don’t think so. For this reason (and others that we have related in our prior messages), we remain convinced that being fully invested in a well-diversified portfolio is the best approach to securing your long-term financial future.
Having said that, we continue to take actions to protect your portfolio during the volatile period we are in, while preparing for “things to return to normal”. Before getting into the details of those actions (and what “normal” means), let us lay out our guiding strategy.
We have always been, and remain, strategic asset allocators. Proper long-term asset allocation, not market timing or over-reliance on stock-picking, has consistently proven itself to be the winning approach. Diligent rebalancing, to stay true to your target asset allocation, is an integral part of that approach. However, there are those very rare times when key economic and financial conditions — those that make asset allocation and rebalancing work (such as lack of correlation among asset classes) — go temporarily haywire. The world has been in that state since mid-September. We acknowledge that, and have been operating since then under a strategy that has the following elements:
- Making tactical adjustments to our lower-level asset allocations based on our collective informed judgment (more on those in a moment), without disrupting the allocations in a major way at the higher, broad-asset-class level
- Developing market diagnostics that will help us determine when conditions have reverted to a state “normal” enough for us to return to traditional asset allocation and rebalancing at the lower level
- Designing risk management mechanisms to provide downside protection to your portfolio during both normal and abnormal times (more on this later, also)
The tactical adjustments we reference above include:
- Trimming your exposure to real estate and to the finance sector, while maintaining your allocation to the broad alternative and equity asset classes, respectively
- Moving from Treasury bonds to high-grade corporate bonds
- Purchasing specific stocks outside of our traditional industry sectors due to the potential we believe those stocks represent
- Temporarily replacing international investments with their domestic counterparts while the dollar is strengthening over the short term
- Placing half of your commodity exposure in a type of fund (specifically, the Direxion Commodity Trends Fund) that tends to do well when commodities experience pronounced moves in either direction
- Working with you to hold a sufficient amount of your portfolio in cash to cover the number of months of living expenses that will give you peace of mind
- Putting newly-deposited cash (if substantial in amount) to work in the markets gradually, by dollar-cost-averaging over a period of time
- Investigating other alternative investments, such as water and farmland
We would be pleased to discuss any of these tactical actions in more detail at your convenience. But please be assured that they are being undertaken within the context of our guiding strategy outlined above.
With respect to the risk management mechanisms cited above, we want to achieve two things. We want a device to protect your portfolio on the downside during bad times; and we want that device to not be a drag on your portfolio during good times. This is not an easy combination to accomplish, and we do not believe it is achievable with off-the-shelf investment products. We are therefore working with all due haste on a mechanism that is custom-designed to the mix of asset classes in your portfolio and will be reporting the details of that effort to you shortly.
On balance, we are optimistic about the future, and believe you should be also.
As always, please call us with any questions.
Your Team at Brinton Eaton