There is a better way to monitor and control risk exposure in a securities-based investment account.
Sawtelle Financial Managementuses a system of investment management based on the law of Supply and Demand, the most fundamental determiner of stock prices. find out more
SFM does not charge management fees when the account(s) are not profitable, measured since inception of the accounts.
"The sum total of your accounts will not be charged a management fee in any quarter the sum total of your accounts are not profitable, measured from the inception of the agreement."
Please read the SFM Policies, Philosophy, & Procedures for further information about how we conduct business.
How Will It Affect Your Retirement Account?
Neither history nor the current evidence supports another bull market at this time in the US stock market. The evidence indicates that we are in the early stages of a long term bear market. If the previous statement is true, most investors are still unprepared to correctly manage their accounts in a long term down market. Traditionally practiced asset diversification does not work effectively in a long term bear market. Further, there is a very high correlation that exists between the US market and foreign markets, and all asset classes in the US market with each other. Said another way: When the S&P 500 drops, most foreign and domestic large capitalization stocks drop with it. Seventy percent of US investors' assets are invested in large capitalization growth and blend stocks. This is an unsettling proposition for the millions of baby-boomers who are getting close to retirement and do not have twenty years to make up a severe loss from their retirement account. These investors should be looking for a different strategy that monitors risk exposure on a daily basis; a strategy that can preserve capital in a declining bear market, and increase capital in a rising market. This investment strategy uses a different method to manage risk than simply buying, holding and hoping that the passage of time will cure all ills. People over age 50 do not have the luxury of time to recover from poor market performance.
How Long Could This Bear Market Last?
We have just completed an 18 year Bull Market, (1982-1999), and it is unlikely that we will have another long term Bull Market any time soon. Looking back at the last eight major market cycles, we can see that each cycle lasted from four to twenty-four years. Attached is Crestmont Research’s Secular (long term) market chart showing the history of every bull and bear market since 1901. Study this chart carefully. It clearly shows that no Bull market began with high Price to Earnings ratios, and no Bear market ever began with low P/E ratios.
In 2000, we completed an 18 year up market. What comes next? For those who know their market history, a bear market! Now is the time for all investors to consider a different strategy than you have used in the past for your retirement account.
This is what Robert Schiller in his excellent book, The New Financial Order, and Ed Easterling in his book, Unexpected Returns, say about the current market prospects:
No bull market, since 1901, has ever begun when the Price to Earnings ratio of the S&P 500 was over 12. It is currently over 23. (Some say 34 from consistent overstatement of earnings.)
Every bull market has begun when prices (as measured by the Consumer Price Index) were moving towards price stability, not away from price stability. In 1982, the CPI was 6%, and dropped to 2% by 1998. In the 1942-1965 Bull Market, inflation was 11% in 1942 and dropped to 2% by 1965. The reverse conditions are in place now. The monthly inflation rate this month, May, was .8%, the highest in 10 years. Year to date, through 5/23/05, inflation is 2.2%. We are moving away from Price Stability. Last year it was 3.5%.
Therefore, there is no room for stocks to go higher. Many of the better financial writers, advisors, and analysts agree. These are the same people who in 1998 and 1999 were saying that the party was over. (Jim Chanos, Kynikos Associates, Gail Dudack, Sunguard, Steve Leuthold, Leuthold Weeden Capital Management, Richard Russell, Dow Theory Newsletter, Marc Faber, PhD, The Boom, Gloom, and Doom Report, and perma-bear James Grant, Grant’s Interest Rate Observer, to name a few.)
If it is true that we are in the early stages of a Bear Market, then what is the best strategy for managing risk exposure in the Optional Retirement Plan? First, this is the worst strategy: Blindly investing in indexes and large capitalization growth US stocks in a stock market recession.
What should I be doing? Measuring money flow and developing a plan based on the simple fundamentals of market pricing of any market based product: Supply and Demand.
What will not work over the next several years? The passive “buy and hold” type strategies such as asset allocation based on Modern Portfolio Theory (Markowitz) and the Capital Asset Pricing Model (Sharpe), worked fine between 1982 and 1999. For an investor with a ten to twenty year time horizon, these investment strategies will be seriously challenged between 2000 and 2015.
This is our method, briefly explained. We actively monitor risk exposure in the account on a daily basis by following money flow; supply (selling) and demand (buying). This makes more sense than buying and holding. The failure to monitor money flow and market sector strengths and weaknesses (rotation) leaves investors without a concrete plan for protecting retirement accounts. Without a logical risk management strategy, most retirement accounts have no effective plan for getting the money out of the way; or to the sidelines during the market declines of a bear market. Witness the past seventeen months, since January 2004. There has been approximately six up months out of the last seventeen. The rest were negative months.
Three features not found in most 403b accounts are crucial for preserving capital in today’s market: active risk monitoring; using relative strength to invest in the strongest sectors of the market; and the ability to take action in a declining market. Without these three key activities, many accounts will experience severe losses, (losses of 10% or more), similar to what we saw between 2000 and 2002.
Here’s what Ed Easterling said in his great book, Unexpected Returns: “…the traditional approach to investment management relies on the direction of the markets. It is a patient, relative return approach that enjoys gains when they occur and suffers losses during market declines. Historically, over long periods of time, the gains have exceeded the losses. In this approach, risk is your friend; based on the principles of Modern Portfolio Theory and the Capital Asset Pricing Model, it is the driver of your returns. This is the Draconian philosophy of investment management: No pain, no gain.”
ORP participants, most especially fifty plus year old baby-boomer participants in the Optional Retirement Plan, must have more than conventional asset allocation and HOPE to successfully get through the BEAR market years that lie ahead. Losses at this stage of the game are least affordable and most difficult, practically impossible, to recover from.
Who is watching for high risk exposure in your Optional Retirement Plan? What strategy is being used to get your money to the sidelines during a market decline? How is the account being managed for risk?
Is your account protected from a possible catastrophic loss?
1. Unexpected Returns, Ed Easterling, Cypress House, 2005, p, XVI
2. The New Financial Order, Robert Schiller, 2003