While it may be an oversimplification and/or the understatement of the year, it is safe to say that the investing world has undergone a massive change over the past decade or so. In short, the landscape as well as the business model and culture of Wall Street have changed completely. The investment strategies once thought to be bullet proof are now riddled with holes. And cutting directly to the chase, the question of the day that every investor, portfolio manager, trader, etc. needs to ask is: Am I keeping up with the change or simply hoping things will return to “normal?”

Although I don’t want to spend my few minutes this weekend beating a dead horse or sending readers into a state of depression, the point to this week’s big-picture missive is this: It is vital that investors and financial services professionals alike understand that they have got to make a change to both their thinking and their approach to the markets if they expect to succeed in the "new normal."

It’s Time to Think Differently

Think back for a moment and ask yourself the following questions. Have those asset allocation strategies that were all the rage performed well over the past decade? How have those buy and hold mutual funds done? Has Modern Portfolio Theory really done its job? Did diversification by style or even asset class do you any good during the Credit Crisis? And finally, should we expect things to return to “normal” any time soon?

Let’s focus on the concept of “normal” for just a moment. One of the biggest problems for investors these days is the “normal” they grew up with turned out to be one of the greatest secular bull markets in history. Remember, the mutual fund industry was really born in the early 1980’s. So, the concept of buy-and-hold that has been espoused ever since is really a strategy based on a raging bull market environment. And in all honesty, from 1982 through 2000, the game was easy – buy and then buy some more!

However, anyone that’s been in the business a while (I guess we’re called gray-beards now) knows that the 1982 – 2000 period wasn’t actually the norm and that investors growing up in the market during the previous cycle (1965 – 1982) had a completely different view of the game.

While I’ve used this stat a fair amount over the last couple of years, I’m going to repeat it again this week for emphasis. From 1/1/2000 through 6/30/2009, the average growth mutual fund (as defined by the Lipper Large Cap Growth Fund Index published in the Wall Street Journal) sports a total return of… wait for it… -47.20%. Yep, that’s right, if you had decided to start the new century off right and plunked $10,000 into that growth fund index, you would now be looking at an account value of $5,280.

Unfortunately, a more conservative asset allocation strategy hasn’t been the savior it was billed to be either. For example, according to our internal numbers, that same $10,000 invested in an allocation of equal parts Lipper Large Cap Growth, Lipper Global, and Lipper Government Bond since 2000 sports a cumulative return of -6.53%. Sure, that’s significantly better than the devastating loss seen in growth funds, but hey, do you think anyone really expected to lose money on a “more conservative” asset allocation strategy over a 9.5 year period?

The New “Normal”

The point is the “normal” we’re dealing with now is no longer a secular bull market. In fact, it appears to be just the opposite; a secular bear market – and is one that could linger for quite some time. So, should we really expect the same strategies that worked so well during a raging bull to work during a secular bear?

We do believe we saw the low point of this cycle and perhaps even a generational low on March 9th. And the 40% rally off the bottom has certainly been enjoyable. We’ll even suggest that this “mini bull” may have a fair amount of upside left. But, the new “normal” is also an economy that is facing some rather severe and persistent headwinds. Thus, the big-picture upside for U.S. stocks will likely be limited for some time.

By now, most everyone who has a 401(k) plan can cite the issues facing the economy. The massive debt burden, the housing dilemma, the jobs picture, and a consumer who’s attitude and behavior will likely be much different than the old “normal” free spending ways.

Now toss in a government that wants to be “hands on” in everything from banks to insurance to health care to credit cards and even cars, and it becomes clear that corporate profitability may be a bit below “normal” going forward.

The bears also like to bring up the massive amount of money that the U.S. plans to borrow during this period of “bail, borrow, and print.” Our furry friends point to the fact that bond buyers are starting to balk by demanding higher rates and then suggest this will be a reason that the economy could struggle if the unintended consequence of the plan winds up being a serious bout of inflation.

Focus on Absolute Return!

I am sure that this less than optimistic view may cause at least a few readers to throw up their hands and start looking for a place in the backyard to bury their savings. However, this is NOT the point.

No, the point of this week’s stroll down Big Picture lane is investors need to break away from the old school way of thinking and focus their investing efforts on ABSOLUTE RETURN. Remember, no one has a gun to your head telling you that you must invest in stocks. No one demands that you keep your money in the U.S. or even in dollars.

Do yourself a favor and say “no mas” to the mutual fund industry’s self serving buy-and-hold approach. Forget about those static asset allocation programs. Ditch the idea of investing only in your broker’s latest stock or fund idea. And feel free to question the validity of modern portfolio theory during periods where all markets have a correlation of 1.0.

Instead, focus on “absolute return!” For those that may not be familiar with the term, the idea of absolute return is simple: Find a way to make your account go up each and every year. Remember, there is ALWAYS a bull market somewhere – even if that bull involves going against the U.S. stock market.

Learning to Play the Game Differently

To drive home the point, let’s play a simple game. Think of ANY economic scenario you’d like and then try to determine what would benefit from such an environment. Ready? Here goes… Let’s start with an easy one: An improving US Economy... The investment answer: Yep, you’re right, the U.S. stock market is the no-brainer buy here (but did you also think of energy, commodities and emerging markets?). Next, let’s try a declining U.S. economy… If Government Bonds comes to mind, give yourself a gold star. But, did you also think about shorting stocks?

Now let’s up the ante… What do we do if the bears are right and inflation is the unintended consequence of all this government borrowing? For starters, we can short bonds because yields will rise. Next, we should own commodities. And of course, gold bugs will be dancing in the streets because rising inflation is a wonderful time to be in the yellow metal.

Since there are at least a few people who might be enjoying this exercise, let’s do one more: Stagflation – a stagnating economy with rising inflation. If you will recall, this is what caused many to call for “the death of equities” in the late 1970’s. But in reality, this is your first clue to the answer. You see, if equities don’t prosper in the environment you’re faced with, then simply avoid them and look elsewhere. Might there be other countries around the world that are doing well and not struggling with stagflation (think China right here, right now)? Might there be asset classes that could benefit? The answer is unequivocally – YES!

New Tools Open the Game to Everyone

Thus, the mindset that investors need these days is to forget about the idea that U.S. stocks are the only game in town. Investors need to open their eyes to the broad array of investment alternatives available to them.

While the idea of taking what the market gives you will undoubtedly sound simplistic, the problem has been that up until recently only those investors with access to the futures markets, options, and those with the ability to invest in foreign countries could play this game. And THIS is the reason that the hedge fund community was born. (However, why the hedgies weren’t required to register with the SEC is beyond me.)

Nowadays everyone with an ordinary brokerage account can buy steel, short oil, and/or invest in China via exchange traded funds (ETF’s). Although ETF’s have been around a while, the alternative asset class ETF’s are relatively new and have only recently enjoyed the trading volume necessary to be considered a viable investment alternative for the pro’s.

In fact, while the SPY (the S&P 500 SPDR) has been around since 1994, the GLD, which is the ticker symbol for the gold ETF and the granddaddy of the new-age ETF’s, didn’t even hit the street until 2005. So, while the concept of “there’s always a bull market somewhere” has been around for eons, the ability for the investing public to benefit is still relatively new.

In closing, we’d like to encourage all investors to open up their eyes to the investment alternatives available to them. We suggest that investors embrace a flexible style and seek absolute returns. Remember, as the always colorful Jeff Macke said last year on CNBC’s “Fast Money,” “2008 will be remembered as the year that buy-and-hold came to die.” So, let’s all make a commitment to think differently and to go where the performance is.

And if you're interested, the TSP FlexPro Portfolio is just such a vehicle.

Wishing you all the best for a profitable week ahead,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

The Week in Review   Week Month YTD Dow Jones Industrial Average -1.62% -3.56% -7.18% S&P 500 Index -1.93% -4.37% -2.67% NASDAQ Composite -2.25% -4.31% +11.35%

 

TSP Chart Review
S&P 500	NASDAQ

 

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