Only when the tide goes out do you discover who’s been swimming naked.
Don’t you think it odd that market sentiment has a habit of changing with the calendar, or more precisely, from one calendar year to the next? Other than a tax-year change, which admittedly is a significant change for some, what really changes overnight from December 31 to January 1? As we go into 2014, our research sources have mostly the same forecast: a year where returns should be high single digits (8 – 9%) with the U.S. economy stronger, Europe on the road to recovery, Asia, both developed and developing, having a mixed bag of problems and more market volatility than we have seen in a couple of years.
A wise old market truism says that as goes January, so goes the year. Unfortunately, back testing data shows this to be correct a high percentage of the time. So with January over and the S&P down almost 5%, the positive returns may be in jeopardy, but the return of volatility is spot on. Many investors, including some prominent academics, equate volatility with risk, but we tend to view this relationship a little differently. Human emotions are sometimes slow to turn and where last year’s fourth quarter showed unadulterated greed, it seems the magic of the calendar year change has reintroduced greed’s counterbalance, fear. Investors knew that our Federal Reserve was beginning to taper its massive quantitative easing program and the initial withdrawal was causing some turmoil in the emerging markets debt and currency markets, but they just kept buying and buying global stocks right up until New Year’s Eve!
As we review portfolios at any time, but especially in last year’s fourth quarter, we do so with the intent of investing any new cash accrued. We typically hold only 2 – 4% cash by design, so this is an endeavor of asset allocation. Also, we have software that allows us to study our portfolios back tested with the actual assets used in their construction. With these reviews, the cash percentage numbers were quite dissimilar – about 3% cash we hold on purpose to over 12% showing in our models. Why such a discrepancy? Some of our investment managers tend to reverse the greed / fear equation that leads to volatility by accumulating cash as excess greed builds and then deploying that cash as volatility, lower prices and some sanity returns. This past month has given us a small taste of this smoothing process.
So if we don’t completely agree with many market participants on risk, how do we define it? Longview really views risk not as volatility per se, but as the “permanent impairment of capital”, a loss so deep that you could not accomplish the monetary life goals you intended. We view volatility as a necessary reset, where our investment managers get us collectively better values and the investment markets return closer to stable conditions
We wish you all a good investing year and as always, we are very appreciative of your continued confidence.
Jeffrey Cedarholm is the Chief Investment Officer at Longview Financial Advisors, Inc. He is a CERTIFIED FINANCIAL PLANNER™ practitioner with a passion for investment and wealth management. Jeff can be reached via e-mail at firstname.lastname@example.org.
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