In these weekly market commentaries, I refer regularly to active investment management. This active management could also accurately be called active risk management or active asset allocation. Very simply, each describes an ongoing investment strategy where the investment advisor or the investor employs a hands-on approach in an attempt to control risk or to improve returns.

This differs substantially from the traditional myth perpetuated by Wall Street that the best way for investors to make money in the stock market is to passively buy and hold. Major Wall Street firms all have colorful charts that show that over time, major stock indices like the Dow or the S&P 500 will outperform virtually every other investment. Unfortunately, those Wall Street firms fail to mention that stocks have a history of producing little or no gains over extended periods.

Let me explain the differences in the two approaches by comparing each to fishing.

In the passive approach, we take our boat out into the open water and drop anchor. One spot is just as good as another because we believe at some point the fish will swim past our position. We bait our lines and toss them into the water. Then we wait for as long as it takes for a hungry fish to come along and bite. According to Wall Street, we don’t need to ever change our bait or our location because eventually we will be in the right spot at the right time. If we want to increase our chance of catching fish, Wall Street says we can diversify by changing to a new random location every hour whether we are catching fish or not.

As an avid angler, I see many people who follow that approach to fishing in spite of having very limited success. Here are some of the reasons people use this fishing method:

• They got lucky using this technique in the past so they see no reason to change
• They have limited angling experience
• They don’t know much about the habits of the fish they are trying to catch
• It takes very little effort
• They have never had anyone show them a better way.

In contrast, an angler using an active approach will steer his boat to a spot on the water that provides likely habitat for the specific type of fish he seeks. He understands that 90% of the water is devoid of fish at any given time, so he might even employ a sophisticated electronic fish finder to make certain there are fish below him. He will use a bait specific to the fish and to the outside conditions. If he doesn’t have immediate success, he will change baits in an attempt to get the fish to bite. If that doesn’t produce results, he will quickly move to another location. He will repeat this process until he catches fish.

All commercial anglers and professional sport anglers use the active angling system. Their livelihood depends on catching fish, so they cannot afford to passively wait for the fish to eventually come to them. Similarly, Wall Street professionals do not follow the approach they espouse for ordinary investors. To understand why, lets go back to our fishing example.

Imagine that you are a fishing guide. For years you have studied specific locations and learned the habits of the fish. You have spent an enormous sum on boats, tackle and other equipment. People pay you well to have you help them catch fish. But you understand that how much money you make depends on your clients’ successes. If they don’t catch fish, you will soon be unemployed.

Now imagine that you are standing next to your boat on the dock one morning. An expensive SUV pulls up and a well-dressed man and his family climb out. The man announces that they have come to enjoy a few days of fishing and would like some tips about the best spots and methods. You tell him that you would love to help them out and you quote him your normal daily rate of $500. He responds that $500 seems much too expensive for something he is sure he is capable to doing on his own. He repeats his request for information and offers you a $40 tip.

Obviously, for $40 you cannot afford to give him the information he needs to be successful. You have invested huge amounts of time and money to learn how to help people catch fish. If you sell that information cheaply, you will soon be out of business. On the other hand, money is money. You take the $40 and tell the man to take his family down to an overhanging tree, to bait his hook with a worm and to wait for a bite.

A few minutes later another vehicle pulls up and another family gets out. They gladly agree to your $500 rate and in minutes, they are in your boat zooming to a spot that virtually always produces lots of fish. It is far across the lake from where the city sewage pipe empties into the lake under the overhanging tree. You never give a second thought to the other family you sent to that spot. Perhaps they will catch some fish and perhaps they won’t. It doesn’t really matter because you’ve got the money you need for the day, plus an extra $40 that you can use to take your spouse to dinner that night.

Small-time investors who do their own investing and have online accounts with discount firms are like the first man in this example. The big Wall Street firms have no incentive to help them be successful. So is the fishing guide worth the $500 a day he is charging? Only the customer and the marketplace can tell us whether or not his service is fairly valued. The same is true when it comes to paying someone to manage your investments.

A March 26, 2008 Wall Street Journal article noted that over the past decade, stock gains are minimal. “The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.

“The Standard & Poor’s 500-stock index, the basis for about half of the $1 trillion invested in U.S. index funds, finished at 1352.99 on Tuesday, below the 1362.80 it hit in April 1999. When dividends and inflation are factored into returns, the S&P 500 has risen an average of just 1.3% a year over the past 10 years, well below the historical norm, according to Morningstar Inc. For the past nine years, it has fallen 0.37% a year, and for the past eight, it is off 1.4% a year. In light of the current wobbly market, some economists and market analysts worry that the era of disappointing returns may not be over.

“Conventional stock-market wisdom holds that if investors buy a broad range of stocks and hold them, they will do better than they would in other investments. But that rule hasn’t held up for stocks bought in the late 1990s or 2000.

“Over the past nine years, the S&P 500 is the worst-performing of nine different investment vehicles tracked by Morningstar…”

Fortunately, investors do not have to sit passively and watch their portfolio assets decline month after month during a bear market. Since October 2007, the stock market has seen a significant decline. Under a buy-and-hold philosophy, investors who have participated fully in the downturn have seen their account values drop as much as 20%. That is exactly the type of situation active managers attempt to avoid.

Below is a chart that illustrates what active management attempts to accomplish. The gold line is the S&P 500. The black line is iShares Lehman 20+ Year Treasury Bond (TLT).  Look at the downward path of the S&P 500 since October 2007 accented by the blue arrow. If an investment advisor practicing active risk management had switched your account from being invested in the S&P 500 to a money market fund in October, what is the value of avoiding the ensuing 17% loss?

Unfortunately, even the best investment managers usually don’t have that kind of perfect timing. Look at the point marked by the red circle. What if an advisor at about this point advised moving client assets to TLT because his indicators showed that bonds were gaining strength when compared to other investment alternatives? For a few weeks, that decision would seem to be questionable because the S&P 500 advanced strongly for eight weeks while bonds foundered. In hindsight, it was brilliant.

While the S&P 500 is only about 5% below that mid-August level, bonds (TLT) have gained about 10%. In the process. clients also avoided much of the volatility they would have experienced had they been invested in the S&P 500 Index during that time. So can we quantify the value of active investment management? In this case the value is about 15% or $15,000 for a $100,000 account. During that period a $100,000 account would have been charged fees of about 1.5% or $1,500. So one could argue that in this case, the value of the active management was a gain of $13,500.

The real strength of active management is seen during bear market periods. There are numerous studies that show active management does not improve portfolio returns during powerful bull markets. But when it comes to actual account values, avoiding major losses has a greater statistical impact than similar gains. After all, it takes a 100% gain to erase a 50% loss.

F.S.

The current market downturn is approaching the end of five months and at this point, there aren’t many who think the worst is over. We have seen a couple of impressive single-day rallies over the past few weeks, but they have not been enough to reverse the downward trend. In spite of the Fed’s best efforts to keep the economy on track there might not be any way to reverse this slide because there are too many uncertainties right now.

When it comes to analyzing the current situation, the easiest way to make some comparisons is probably to review past corrections. Below is a chart showing the past 10 years of market activity and by any measure, it is apparent that this correction is significant. The black line is the price movement of the Dow and the gold line is the S&P 500. Over this period, the only two years that have produced larger corrections were 2001 and 2002. But this year and this correction are far from over.

One thing you’ll notice is that even in 2001 and 2002, sharp downward moves were usually followed fairly quickly by significant upward moves. We are not seeing a similar reaction today. The one- to three-day rallies we’ve seen recently have not been enough to undo the damage that is occurring on the down days. It would be nice to believe that the markets are overdue for some sort of recovery, but the bad news just keeps coming. This week it was $110 a barrel oil and the problems with Bear Stearns.

The bottom portion of the chart is a moving average convergence divergence (MACD) for the Dow. While it shows that the Dow is generally in an oversold state, that does not mean a turnaround is imminent. Before that happens there has to be some reason that investors would want to step back into the market and start buying. Right now, the best hope would likely be first-quarter earnings reports that start appearing in April. If investors see evidence that companies are continuing to profit in spite of spending cutbacks and higher prices, then we could see a market recovery. On the other hand, if the earnings reports are bleak, chances are the economy is in for a very long and very bad year.

So far the presidential candidates don’t seem to be focusing much attention on the economy. They keep getting distracted by the war, racism, sexism and religion. They might do well to reflect on the success of former President Bill Clinton’s first campaign where he beat incumbent President George Bush by reminding voters at every opportunity that the most pressing issue was the economy. The latest polls show that none of the remaining candidates enjoys a significant lead and none have a majority of support. My guess is that right now most Americans are far more concerned about the economy than any other issue. The candidate who can convince voters that he (or she) can quickly fix the economic mess would likely take the lead.

The markets are closed tomorrow for Good Friday and the Easter holiday. Have a great weekend and I hope you have some nice spring weather.
F.S.

If you would like investment strategies that attempt to minimize risk but still provide the opportunity for solid growth, check out the offerings from Strategis Financial Group.  For information, call 800-279-3377.

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There have been numerous sensational headlines about the financial markets in recent days. The price of gold and the price of oil have reached all-time highs. The U.S. Dollar reached record lows against many currencies. Economists agree that the economy is now in recession. And the governor and former attorney general of New York resigned amid a sex scandal.

Any of these situations alone could result in significant market moves. When several occur at the same time, their impact is magnified and triple-digit moves in the Dow become the norm, rather than the exception.

Last week I wrote about gold and oil and nothing has changed as those sectors remain the strongest. This week much of the news has focused on the resignation of Eliot Spitzer, but the coverage has primarily dealt with his sexual dalliances. As a result, you might have missed the fact that when Spitzer’s problems were announced, traders on Wall Street cheered.

When he was New York’s attorney general, Spitzer aggressively went after what he described as corruption on Wall Street. But his actions reverberated far beyond the big brokerage and trading firms he was trying to clean up. Spitzer always seemed more concerned about generating headlines than he was about protecting the interests of ordinary investors. He tended to use a cannon when a BB gun would have been more appropriate. In doing so, he often harmed small investors while helping the big Wall Street firms he was attempting to rein in.

As an investor, if you have ever been frustrated by trading restrictions or fees imposed by mutual fund companies, chances are you can attribute it to Spitzer’s actions. As attorney general, Spitzer believed that some fund companies granted unfair trading privileges to some of their bigger clients. Fund companies reacted by clamping down on trading activity for all of their clients, including small individual account owners.

During his tenure, Wall Street insiders wondered publicly why he went after activities that the Securities Exchange Commission and the National Association of Securities Dealers did not perceive as problems. He professed a policy of zero tolerance for violations and companies that came under his scrutiny would quickly admit to wrongdoings just to get his agency to leave them alone.

Spitzer now finds himself the target of an investigation, rather than the instigator of it. For those on Wall Street, the irony was too rich to ignore.
F.S.

If you would like investment strategies that attempt to minimize risk but still provide the opportunity for solid growth, check out the offerings from Strategis Financial Group.  For information, call 800-279-3377.

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Over the past few months, investors have been watching the value of their portfolios decline. Most have remained hopeful that this would be a temporary situation and stocks would come roaring back as they have many times in the past. Now, each day that goes by more and more investors realize that this correction is probably going to get worse before it gets better. They are wondering where they should put there money to prevent further losses.

During strong bull markets, it is easy for almost anyone to think of himself as an investment genius. A bull market is like a rising tide: anything that floats is going to go up even if it is just worthless junk. When the tide eventually goes out, you want to make certain your boat is in a safe harbor so you don’t end up stranded on the exposed rocks.

A decade or so ago, mutual funds that short the stock market were introduced and were hailed as the salvation for bear markets. At last investors would have a vehicle that allowed them to make money in down markets. Today there is a wide range of short funds that allow investors to play the downside of almost any index or sector. Unfortunately, these funds have not proved to be a bear market panacea for investors. It is still difficult to make money during a correction because down markets do not behave like strong bull markets. They tend to be more volatile and trends are less pronounced.

So for investors who don’t want to just sit on the sidelines until this bear market runs its course, what are the investment alternatives?

Over the past six months, virtually every segment of the market has been in a downturn. That is an unusual situation that rarely occurs except during serious economic recessions. Chances are, you are already aware of the sectors that are advancing. Below is a chart that shows the current situation. The black line is the Nasdaq and is included to show how the general equity markets have fared.

Representing energy, the strongest sector, the red line is iPath S&P GSCI Crude Oil Total Return Index ETN (OIL). Doing almost as well and with a less volatile trend, precious metals are represented by the gold line– StreetTRACKS Gold Shares (GLD). While both of these sectors have done well over the past six months, they are probably too volatile for most investors. Often they are not even an option. An investors moving among the fund choices in his 401K, for example, might not even have an energy fund or precious metals fund to choose.

The strongest sector that has a reasonable level of volatility is bonds. In the case bonds are represented by the blue line which is Lehman Long-term treasury SPDR (TLO). Strategis Financial Group client assets have largely been invested in bonds since fall of 2007 and have produced decent returns since then when compared to U.S. equity markets. Some assets have also been allocated to gold and to energy.

Today the major indices fell to new 52-week lows. In fact, the Dow is at the same level as in November 2006. The Nasdaq and the S&P 500 are both at about the same levels as at the end of 2005.

With Federal Reserve Chairman Bob Bernanke earlier this week telling Congress that the economic situation is likely to worsen, there is little for investors to be encouraged about right now. Today the Federal Reserve reported that Americans’ percentage of equity in their homes fell below 50 percent for the first time since 1945. That certainly is a bad sign since homes are the single biggest source of wealth for most American families.

Unfortunately, we are probably just in the early stages of this economic downturn and there will be more bad news to come.

F.S.

If you would like investment strategies that attempt to minimize risk but still provide the opportunity for solid growth, check out the offerings from Strategis Financial Group. For information, call 800-279-3377.

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