The Last Shall Be First

May 8, 2009

“So the last shall be first, and the first shall be last.”

Although Jesus probably wasn’t talking about the tendency for the most beaten down stocks in a bear market to become the best performing stocks coming off the bottom, this scripture in Matthew is certainly an accurate description of what has taken place in the stock market over the past two months.

The S&P 500 declined 57% from its peak on October 10, 2007 to its low on March 9, 2009. Over the last two months, the S&P 500 has rallied over 35%. However, the returns of individual stocks has been highly discriminate since the low. To highlight the discrepancy of individual stock returns, consider the table below:

Signal

Column

Avg Return Since 3/9/09

Buy

X

28.12%

Buy

O

45.72%

Sell

X

52.85%

Sell

O

102.24%

The table above categorizes all of the mid and large cap stocks in the S&P 900 by their Point & Figure relative strength rank on March 9, 2009 and shows each group’s performance since that time. For those who may be unfamiliar with Point & Figure Charting, the following explanation may be helpful:

Combination

Description

Buy Signal / Column of Xs

Strong LT RS / Strong ST RS

Buy Signal / Column of Os

Strong LT RS / Weak ST RS

Sell Signal / Column of Xs

Weak LT RS / Strong ST RS

Sell Signal / Column of Os

Weak LT RS / Weak ST RS

Although extremely unpleasant for High RS strategies right now, one of the virtues of RS is its ability to adapt to new leadership over time!

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Emotional Asset Allocation

May 8, 2009

The steep losses experienced by investors over the last year and a half have led to many changes in investor behavior. The personal savings rate is ticking up, some measure of frugality has returned to the consumer, and the asset allocation framework in place for many investors is being seriously questioned. Among the changes has been a dramatic reduction in appetite for risk among investors. In fact, 56% of Baby Boomers have now concluded that the stock market is too risky for people their age (San Francisco Business Times, 2/13/09).

This change in appetite for risk is manifested in the floods of money pouring into bond funds, as can be seen in the table below (Investment News, 5/4/09):

Morningstar Category

1Q’09 Net Flows
1. Intermediate-term bond $24,076
2. Precious metals 14,991
3. High-yield bond 7,673
4. Natural resources 6,765
5. Short-term bond 6,210
6. Municipal national short 5,214
7. Long-term bond 4,647
8. Inflation-protected bond 4,551
9. Municipal national intermediate 3,423
10. Intermediate government 3,395

As investors throw their hands up in despair, torn between putting the bulk of their assets in bonds or embarking on an experiment with day-trading financial stocks, I suggest presenting them with the following data. Right now, you may be thinking that you are about to read some fascinating new piece of data. Fascinating is probably not the adjective for life expectancy-data, but perhaps nothing is more important to consider when deciding what changes investors should make right now. The following data is taken from the Centers for Disease Control and Prevention, updated through 2005.

U.S. Life expectancy at birth

Men

75.2 years

Women

80.4

U.S. Life expectancy at age 65

Men

82.2 years

Women

85.0

U.S Life expectancy at age 75

Men

85.8 years

Women

87.8

Emotions are running extremely high right now, which means that investors are very susceptible to making poor investment decisions. Any radical changes in framework for asset allocation should be done with the long-term in mind, especially now. Keep in mind that life expectancy means that one-half of the sample will live shorter than the expectancy, and one-half of the sample will live longer. After all, it is very likely that many of your clients will live well in to their eighties or nineties. With that in mind, a diversified bond portfolio doesn’t make a whole lot of sense; nor does it make much sense to embark on some unproven trading strategy.

When empirical evidence is used, relative strength and tactical asset allocation appear in a very favorable light.

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