Market Anxiety Disorder

April 7, 2010

A recent article in the Personal Finance section of the Wall Street Journal had a prescription for anxious investors that Andy has been talking about for more than a year: consider asset allocation funds. Our Global Macro separate account has been very popular, partly because it allows investors to get into the market in a way that can be conservative when needed, but one that doesn’t lock investors into a product that can only be conservative.

The stock market’s powerful rally over the past year has gone a long way toward reducing the losses that many mutual-fund investors suffered in late 2007 and 2008.

But the rebound—with the Standard & Poor’s 500-stock index up 74% from its March 9, 2009, low—has done nothing for one group of investors: those who bailed out of stocks and have remained on the sidelines. Some of these investors have poured large sums into bond funds, even though those holdings may take a beating whenever interest rates rise from today’s unusually low levels, possibly later this year. Some forecasters, meanwhile, believe that stocks may finish 2010 up as much as 10%.

So, for investors who want to step back into stocks but are still anxious, here’s a modest suggestion: You don’t have to take your stock exposure straight up. You can dilute it by buying an allocation fund that spreads its assets across many market sectors, from stocks and bonds to money-market instruments and convertible securities.

While the WSJ article is a good general introduction to the idea, I think there are a few caveats that should be mentioned.

There’s still a big difference between a strategic asset allocation fund and a tactical asset allocation fund.

Many [asset allocation funds] keep their exposures within set ranges, while others may vary their mix widely.

Your fund selection will probably depend a lot on the individual client. A strategic asset allocation fund will more often have a tight range or even a fixed or target allocation for stocks or bonds. This can often target the volatility successfully–but can hurt returns if the asset classes themselves are out of favor. Tactical funds will more often have broader ranges or be unconstrained in terms of allocations. This additional flexibility can lead to higher returns, but it could be accompanied by higher volatility.

One thing the article does not mention at all, unfortunately, is that you also have a choice between a purely domestic asset allocation fund or a global asset allocation fund. A typical domestic asset allocation fund will provide anxious investors with a way to ease into the market, but will ignore many of the opportunities in international markets or in alternative assets like real estate, currencies, and commodities. With a variety of possible scenarios for the domestic economy, it might make sense to cast your net a little wider. Still, the article’s main point is valid: an asset allocation fund, especially a global asset allocation fund, is often a good way to deal with a client’s Market Anxiety Disorder and get them back into the game.

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Dr. Copper

April 7, 2010

The Financial Times has an interesting article about copper reaching its highest price in 20 months. Included in the article was a brief discussion about why investors might want to pay attention to the price of copper:

The red metal is known as “Dr Copper”, as if it possessed a degree in economics, because many believe that its price swings anticipate shifts in global manufacturing activity. Copper has only traded above the $8,000 a tonne level during phases of strong economic activity, including the first half of 2008 and brief periods in 2006 and 2007. It hit an-all time high of $8,940 a tonne in July 2008.

Dr. Copper seems to be suggesting that we are in for a period of strong economic activity. Bear in mind that copper, as one of the prime industrial metals along with aluminum, nickel, and zinc, is a global commodity. The demand for copper certainly doesn’t have to come just from the U.S. In fact, in recent years, economic growth has been faster in many emerging markets.

There are a couple of important points here: 1) it may be a mistake to focus your investments entirely in your home country, and 2) supply and demand for copper are painting a very different picture for global economies than most economists are. I’ll let you be the judge of Dr. Copper’s forecasting ability this cycle by including a chart of JJC, the iPath Copper ETN . It bottomed in January 2009, three months before the bottom in the U.S. stock market–and it is still rising.

Click to enlarge. Source: Yahoo! Finance

Disclosure: Some Dorsey, Wright managed accounts own positions in industrial metals ETFs.

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Bond Yields: An Historical Turning Point

April 7, 2010

Source: The Economist

The yield on the 30-year treasury bond yield has moved above its 100-month average. This average has been trending down since the mid-1980s so this is quite a moment (as of 4/6/10, the yield was 4.84% and the average was 4.71%).

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You Can Be Gloomy if You Want

April 7, 2010

But that doesn’t seem to match up with what’s happening in the economy right now. The stock market’s role is to reflect expectations. In 2009 the stock market had its best year in a decade, but forecasters were almost uniformly expecting sluggish growth for years to come. The market’s expectations were clearly much more aggressive.

According to a New York Times article today:

The mood has gone from panicked to cautious, and now, as Mark Zandi, chief economist for Moody’s Economy.com put it, some consumers are “almost a bit giddy.”

The improvement in consumer demand seem to be broad-based, extending even to high-dollar items like autos.

…after months of cutting inventory to bring it in line with weakened demand, the nation’s retailers are ordering more merchandise. The cargo volume at major ports that handle retail imports is expected to increase 8 percent in April compared with the period a year ago, according to the National Retail Federation and the consulting firm Hackett Associates.

“What I’m hearing across a wide swath of retail is that sales are simply much stronger than companies had expected,” said Robert Barbera, the chief economist of ITG, an investment advisory firm.

Anecdotal evidence is also falling into line. The article cites the experience of a retailer in New Jersey:

Lauren Keshet, the owner of Paws and Claws, a pet care company in Hoboken, said her business suffered when the economy nose-dived and consumers snapped their wallets shut. “My business went to half” of what she had been selling, Ms. Keshet said. But today, “my business is booming again,” she said. “It’s really come back.”

So has her spending, and that of other shoppers she has seen lately at the Westfield Garden State Plaza mall in Paramus, N.J. “Right now I’m renovating my house,” she said. “I’m buying furniture.”

Pet care is clearly a discretionary expenditure and the fact that even those types of businesses are expanding bodes well for consumer spending down the road. Far from being “unsustainable,” it now appears that the stock market correctly expected a much stronger rebound than the economists.

One of the reasons that we hew to a systematic approach to investing is precisely because it is in times of emotional stress–when the economy is falling down around your ears–that investors are most prone to believe in a very negative scenario. Investors definitely had this problem last year when surveys indicated that 70% of retail investors did not participate in the rally. (When the economy is rolling, investors are equally likely to believe in a very rosy scenario–and they are equally likely to come to grief for the opposite reason.) Markets based on supply and demand are a much better reflector of expectations than economists’ forecasts. Ignore forecasts and pay attention to what is.

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High RS Diffusion Index

April 7, 2010

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.) As of 4/6/10.

The 10-day moving average of this indicator is 95% and the one-day reading is 98%. This oscillator has shown the tendency to remain overbought for extended periods of time, while oversold measures tend to be much more abrupt.

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