On The Economy And Active Management

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 21, 2008

IN THIS ISSUE:

1.   A Look At The Latest Economic Numbers

2.   Economic Forecasts Roundly Downgraded

3.   Fallacies Of A “Buy-And-Hold” Only Approach 

4.   The Goal Of Active Management Strategies   

5.   The HWM Difference

6.   Is It Time To Try Active Management?

7.   Conclusions – Don’t Miss The Next Bull Market

Introduction

This week, we will take a look at the latest economic numbers which look quite bleak overall.  There is little doubt that the US and the rest of the world are headed into a global recession sparked by the international credit crisis.  The only question now is: How deep and how long?

Following that discussion, I will review the advantages of including active investment strategies in your portfolio.  Long-time readers know that I have been a strong advocate of “active management” strategies, especially those that have the flexibility to move to cash (traditional market timing), “hedge” long positions during market downturns or even go “short” and provide the potential to profit even when the markets decline.  Not surprisingly, such active management strategies are back in demand in the wake of the recent stock market collapse. 

Now that active management strategies are coming back into vogue, I will tell you why I have always been a fan of money management techniques that seek to avoid big losses, especially of the magnitude that we’ve all seen over the last 4-5 weeks.  I think you’ll find that discussion very interesting in light of the recent stock market chaos.

Though I have mentioned the advantages of active management strategies many times in the past, the current market environment has resulted in many more calls to my staff from investors who now seek to include these strategies in their portfolios.  Thus, this may turn out to be one of my most popular E-Letters ever, though it’s unfortunate that investors have had to endure severe losses in their portfolios to make it so.

A Look At The Latest Economic Numbers

We have long known that consumer spending accounts for apprx. 70% of US Gross Domestic Product, and consumer spending is predicated on consumer confidence.  At this point, consumer confidence is in the tank and consumer spending is falling off a cliff. 

The mid-October University of Michigan Consumer Sentiment Index plunged to 57.5, down from 70.3 in the last half of September. This is one of the deepest monthly declines in the Sentiment Index since it has been recorded.  The latest report noted that there have only been four surveys that posted monthly declines of 10 index points or more.  The government’s Consumer Confidence Index to be released next Tuesday is expected to show a similar sharp decline.

So a recession is upon us despite the fact that US GDP rose by a healthy 2.8% in the 2Q.  We may even find that the economy remained technically in positive territory in the July-September quarter when the government releases its first report on 3Q GDP on October 30.  Regardless of what next week’s GDP says about the 3Q, there is little doubt that economic growth will fall into negative territory in the current 4Q.  And it will likely be down a lot.

Not that much else matters when consumer confidence and spending are in freefall, but here are some of the other recent economic reports.

The Index of Leading Economic Indicators (LEI) actually rose 0.3% in September, reversing the recent downward trend.  However, analysts are careful to point out that the rise was primarily due to a large increase in the money supply, essentially masking sharp declines in stock prices and residential building permits and increased layoff activity.  The September increase was also offset by a larger downward revision to August’s LEI.  The leading indicators are almost certain to fall again for October, probably significantly due to the continued washout in the stock markets.

Retail sales fell more than expected in September, down 1.2% following a decline of 0.4% in August.  Chain store sales, including Wal-Mart, declined sharply in September and will almost certainly be down even more this month.  I don’t shop very often, but I was in Macy’s over the weekend and it looked like two-thirds of the store was marked down 40-50% or more.

US auto sales plunged 26.6% in September, making it the first month since 1993 when buyers drove less than one million new cars and trucks off the dealerships’ lots.  Analysts predict that October will be even worse.  GMAC announced on October 13 that it will only make car loans to buyers with a credit score of at least 700.  This is bad!

On the manufacturing side, the ISM Index fell from 49.9 in August to 43.5 in September.  Any reading below 50 in the ISM Index indicates that manufacturing is in a recession.  Factory orders fell a whopping 4.0% in August (latest data available).  I’m sure it has happened before but I don’t remember seeing a 4% drop in one month in the past.

The unemployment rate held steady at 6.1% in September, but this number will definitely go higher for October and the rest of the year as well.

Economic Forecasts Roundly Downgraded

I read and hear a lot of economic forecasts, and every one is being downgraded in light of the events of the last 4-5 weeks.  Other than the gloom-and-doom crowd that always predicts a recession or worse, I don’t know any outfit that predicted what we have seen in the last month or so.  Thus, everyone is having to downgrade their economic forecasts.

The consensus outlook, prior to the last 4-5 weeks, was that the US economic growth would go mildly negative in the 4Q and somewhat more negative in the 1Q and 2Q of next year.  Most forecasters felt the US economy would rebound back into positive territory in the second half of next year. But frankly, I don’t know anyone that has a clear forecast for what happens next year.

The problem is, no one knows for sure if the massive government bailout is going to work.  The Treasury Department is working feverishly to put together the apparatus to begin buying up distressed debts.  It’s a complicated process that is rife with conflicts of interest.  The thinking originally was that the Treasury would be buying assets after the first of the year.  Now they are hoping to be in business before the holidays.  They need to be.

Fallacies Of A “Buy-And-Hold” Only Approach

The stock market collapse over the last several weeks has devastated millions of investors’ portfolios and shattered retirement plans for untold numbers of Americans.  Many investors’ portfolios are down 35-40% or more in just the last 5-6 weeks. The market plunge has brought into serious question Wall Street’s mantra of “buy-and-hold” for the long-term. 

Whether it’s called “asset allocation” or “index investing” or any of a number of other names, the basic premise of buy-and-hold investing is to indefinitely hold a group of investments in hopes they will produce gains in an amount to meet investment goals.  If you have read me for long, you know that I have never been a big fan of having your entire investment portfolio in a buy-and-hold strategy, especially if there is no “risk management” component involved to deal with periodic bear markets. 

Instead, I have recommended “active management” strategies which incorporate risk management techniques.  While active management can include programs that stay fully invested and rotate among market sectors, most of those that we recommend have the flexibility to move to the safety of cash (money market) or “hedge” long positions during bear markets.  Some can even “short” the market and can profit when the market drops.

At Halbert Wealth Management (HWM), we specialize in finding successful money managers that use active management strategies which seek to minimize the effects of bear markets in stocks and bonds.  This is not to say that the strategies we offer cannot lose money in down markets.  Any equity investment has the potential to lose money.  Instead, the Advisors we recommend in our AdvisorLink® Program use sophisticated investment strategies to limit the downside risk of a bear market or major downward correction – something you won’t find in most buy-and-hold portfolios.

We continually search the universe of professional money managers in an effort to find those Advisors who have delivered solid “risk-adjusted” returns and have managed to avoid the huge losses so common in bear markets and major downward price corrections.  As it has turned out over the years, we have found the best risk-adjusted returns among active managers that move out of the market or hedge long positions from time to time to avoid bear markets.

The traditional Wall Street wisdom over the years has been that it is impossible to “time” the market.  They argue that if you are out of the market from time to time, you are likely to miss the best days.  So you should stay fully invested at all times.

Does that argument sound familiar?  I’ll bet it does, especially over the last year or so when you may have wanted to sell out, but your broker talked you into holding on.  Now, with the stock markets down 35-40% or more (and it may not be over yet), it’s probably the worst time to sell out, so you’re stuck.

But there were active managers who limited losses in the latest bear market by moving to the safety of cash, hedging their long positions and/or shorting the market.  This includes many of the equity money managers I have recommended to you in these pages.  Later on, I’ll tell you how to find detailed performance statistics on these money managers, but first let’s look at the underlying premise of one active management strategy known as “market timing.”

The Goals Of Active Management Strategies

Simply put, successful active management/market timing strategies have two basic goals:

1.      Participate in stock market gains in the good times; and

2.      Limit market losses to half or less of equity losses in the bad times.

These goals are simple in concept, I trust you would agree, but more than a little challenging to deliver.  In fact, most active managers we run across don’t succeed in meeting these goals over the long haul.  Yet there are those that have, if you just know where to find them.

To be honest, many money managers and even individual investors can decide to move to cash in bad times.  We are encountering investors who have been on the sidelines for months due to subprime fears.  The real challenge is to know when to get back into the market once the market rebounds. 

It is also important to note that some active money managers go one step further and seek to make money in down markets by entering into “short” sales of major market indexes using specialized mutual funds.  While this is a more aggressive strategy than one that will only go to cash or hedge long positions, it provides investors with the potential to make money even when the markets are going down.

Here is the basic challenge for active managers if they are to beat the buy-and-hold strategy: How do you devise a system that keeps you in the market on most of the good days, but also takes you out (or “short”) when bear markets come along?  Let me say, this is not easy!  And most active managers and market timers are not successful over time.

Those that have been successful over time, generally speaking, have developed sophisticated systems that gauge stock market trends and generate signals for when to enter and exit the market.  This is not seat-of-the-pants, emotional trading, though some Advisors do have some measure of discretion built into their systems. 

There is much, much more to it than this, of course.  It is one thing to be generally correct about the trend – up or down; it is quite another to know which sectors of the market to invest in.  Space doesn’t permit me to elaborate on how successful active managers determine which sectors to invest in, when they get their trend signals, but trust that this is another important variable when it comes to selecting a successful active money manager. 

The bottom line is, there are active managers and market timers out there that have been successful in delivering their clients good returns over time, but more importantly have avoided the sometimes huge losses that come with buy-and-hold strategies.

The key is, how do you find them?  Most investors don’t know how to find these successful active managers.  Most of these successful managers don’t advertise, so they are not household names.  The big brokerage firms are not likely to tell you about them, since they don’t buy into the Wall Street buy-and-hold mantra.  

Truth is, you will probably only find them if you stumble into a boutique investment firm like mine that has the money and the commitment to search high and low for the handful of successful active managers that are out there.

The Halbert Wealth Management Difference

My firm recognizes that we’re not the only company that offers active management strategies to our clients.  We do, however, believe that we have structured our AdvisorLink® Program in such a way as to offer investors the most flexible way to participate in such programs.

In many cases, actively managed investment programs are “packaged” and sold to investors as a single solution.  The selection and retention of each money manager, the types of strategies employed, and the allocation to each participating manager is set by the sponsoring firm.  Think of it as being something like a fund of funds.  There’s nothing wrong with this approach, and we are even considering some of these programs to offer our clients.  However, the drawback of such programs is that they limit the investor to pre-selected options.

At HWM, we have “unbundled” the mix of active money managers so that each is available with or without any of our other managers, and in an allocation that can be tailored for each investor.  Since most of our clients tend to be do-it-yourself investors, we feel it offers them the following advantages:

  1. Due Diligence – I have written a number of times about the extensive due diligence each money manager must endure in order to be added to our list of recommended programs.  We not only subject the numbers to intense analysis, but also the Advisor’s administrative capabilities and business stability.

    We also have face-to-face meetings with each Advisor in order to not only get a feel for his or her grasp of the strategy being employed, but also to get a personal feel for the individual with whom our clients’ money will be placed.  Most of the time, these meetings take place as part of an on-site visit to the Advisor’s office by my due diligence staff.

    We then summarize the results of our findings in an Advisor Profile document that is made available to each prospective investor.  For the investor, this means that the money manager has been subjected to a great deal of scrutiny as to performance, strategy and administrative capabilities.  Thus, a lot of the legwork has already been done for our clients.

    Another part of due diligence is in regard to ongoing monitoring of an active money manager’s performance and operations.  We monitor trading and performance on a daily basis, and communicate with money managers immediately if we notice anything out of the ordinary or not within our expectations for the particular program being monitored.

  2. TransparencyEven before the recent subprime mortgage debacle, “transparency” was a big issue in the managed funds world.  Now, it’s likely to become the law of the land, even for secretive hedge funds.  Fortunately, investors have always enjoyed a high level of transparency in regard to the programs we offer.

    As I noted above, some sponsors of actively managed investments will keep the details of who is managing parts of the portfolio a secret.  That way, they can make a change in the lineup with a minimum of disruption.  However, HWM offers each money manager as a stand-alone unit, providing full visibility of each manager and his or her approach to managing money.  This transparency also allows each prospective client to review a detailed summary of the money manager’s actual performance since the program’s inception.

    Beyond the ability to know and evaluate each individual money manager, investors also are able to see exactly how their money is being invested.  All of the various money managers we recommend offer our clients the ability to follow the trading of their accounts online.

  3. Flexibility – Since we do not offer any set portfolios containing a mixture of money managers available in our AdvisorLink® Program, investors have complete flexibility to combine programs in a way they feel is most suitable for their unique situation.  We have some clients who invest in only one of the programs we offer, while many others choose to allocate their investments among several programs. 

    We feel that combining the various AdvisorLink® investments can offer investors additional diversification beyond just having a variety of different asset classes in a buy-and-hold portfolio.  This additional diversification comes about in a number of ways, including the following:

    ●           Diversification for different market environments.  We all know that a declining market will generally result in losses in a buy-and-hold investment.  However, such a market environment could also result in some active management strategies becoming “neutral” by going to cash or hedging long positions.  In that event, an extended bear market could result in only money market returns.  A combination of investment strategies can provide the potential for making money even in a down market.  For example, it may be suitable to have both a “long or cash” strategy and a program that can go both long or short in the market.  This would provide a potential for portfolio gains even in a declining market.

    ●          Diversification to reduce correlation.  I have discussed correlation of investment programs in past E-Letters, but the basic idea is that two investments are “correlated” if they tend to go up and down at the same times.  It is generally best to include some non-correlated investments in a diversified portfolio.  I have noted before that most of the investment alternatives in our AdvisorLink® Program have a low correlation to the major market indexes.  However, it is also true that many of these programs have little or no correlation to each other

    ●         Diversification among investment strategies.  The recent market meltdown has shown that when times get tough, virtually all equity asset classes suffer.  Even for investors who choose to maintain an asset allocation or other buy-and-hold investment strategy, adding actively managed programs that go to cash or even “short” the market can result in a higher level of strategic diversification. 

  4. Control – A final advantage of our unbundled approach to active management strategies is that you have complete control over what managers are included in your portfolio.  While HWM provides due diligence services and can assist you with making an allocation decision, the final say is up to you.  This keeps you in complete control of your investment destiny.

    Nowhere is this more important than when it comes time to move from one money manager to another.  I often tell prospective clients that few, if any, money managers will ever tell you to fire them.  I am personally aware of Advisors with substandard investment programs who keep promising investors that “things will get better” in an effort to retain their business.

    At HWM, our due diligence and ongoing monitoring will help to identify Advisors whose programs may no longer be suitable for meeting your needs, and we will offer other alternatives.  However, the final decision as to whether to retain a money manager is yours, as it should be.  There are also no “lockups,” early termination charges or any other impediments to accessing your money should the need arise.

In short, the HWM AdvisorLink®Program offers investors a “cafeteria-type” approach to money management.  Do-it-yourself investors can evaluate each money manager on its own merits rather than accepting it as part of a “canned” approach.  For investors who are not do-it-yourselfers, the HWM staff can help evaluate the most suitable mix of money management programs based on the investor’s assets, risk tolerance and investment goals.

Our experienced staff is also available for ongoing questions about the performance of each of our recommended programs, as well as inquiries about specific issues regarding your account.

As you consider the investments that make up our AdvisorLink®Program, it’s also important to remember that none of our Advisors invest in subprime mortgages or anything of the like.  The equity managers I recommend invest in well-known, US-based mutual funds that you probably have heard of and can look up in the newspaper or on the Internet daily. 

Plus, no one on my staff is paid a commission, so there is never any pressure to invest or incentive to sell you something that may be unsuitable for your needs.  On that, you have my promise.  Likewise, we have an ironclad “privacy policy” and your private financial information is never, ever shared with anyone else, other than as may be required by law.

Is It Time To Consider Active Management?

As I noted above, many of my readers have recently contacted us for information on the money managers I recommend in light of the market’s recent meltdown.  They have seen their buy-and-hold portfolios devastated by losses of 35-40% or more.  Retirement prospects have been shattered for millions of investors.  People across the US are now looking for risk-averse ways to invest their money that can deliver market returns with less downside risk.

Earlier, I said that I’d provide a way for you to see how our various programs have fared so far this year.  If you are ready to explore the world of actively managed investments, I recommend that you visit our AdvisorLink® performance summary web page at the following address:

http://www.halbertwealth.com/advisorlink/programs.php

While you will no-doubt notice that some of the programs we offer had year-to-date losses as of the end of September, you will also note that these are far less than those suffered by the major market indexes.  Our goal is to offer programs that limit losses to half or less than those of the market, which means that when the markets turn up again, there’s less ground to make up. 

One noticeable exception to this goal is the Niemann Dynamic Program, which has a year-to-date loss close to that of the overall market.  The reason that losses have not been limited is that this particular program is a high-octane long-only program that is always fully invested.  Niemann does not have the option to go to cash or hedge any of Dynamic’s positions, so it suffers in down markets.  However, I also urge you to look at the long-term performance of this program as compared to the S&P 500 Index.  Of course, past performance is not necessarily indicative of future results.

Conclusions – Don’t Miss The Next Bull Market

The stock markets have imploded in the last 4-5 weeks on a scale that virtually no one anticipated.  Buy-and-hold strategies are down nearly 35-40% or more in less than five weeks.  Americans’ retirement plans are now turned upside down.

I certainly don’t have all the answers.  But I do have some suggestions for avoiding the huge losses that have occurred in just the last few weeks.

I have argued these points about minimizing losses for over five years in these E-Letters.  I have argued my thoughts about active management strategies that seek to minimize losses in market downturns.

Maybe now is the time to do something about it. 

I don’t know when the stock markets will bottom.  Much depends on how quickly the credit markets free up.  Whenever the market bottoms, I fully expect we will see a powerful bull market emerge.  When that happens, you want a professional manager that will get you back in the market for the next run.

A very successful money manager once told me the following: Investors think they pay us our management fees to get them out of the market during the down periods.  But what they really pay us for is to get them back in when the market heads higher again.

This is so true, I believe.  Millions of investors have bailed out of the market in the last few weeks.  Sadly, most will not know when to go back in.  The only way to recover the massive losses that have been experienced over the last couple of months is to participate in the recovery.

The professional Advisors I recommend have histories of catching major trends in the market – both up and down.  And you don’t want to miss the next bull market.  Maybe it’s time to get the professionals I recommend on your team. 

If you are ready to join the ranks of investors who are putting active management strategies to work for them to reduce the risks of being in the market, I urge you to contact us about the various opportunities available in our AdvisorLink® Program.  Feel free to call one of our Investment Consultants at (800) 348-3601, or send us an e-mail at info@halbertwealth.com.  You can also request additional information about our risk-managed investments by completing one of our online request forms.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

How to Read the Constitution (By Justice Clarence Thomas – A Must-Read!)
http://online.wsj.com/article/SB122445985683948619.html

Get Ready for the New New Deal
http://online.wsj.com/article/SB122455099434052597.html

The Coming Pink Slip Epidemic
http://www.businessweek.com/bwdaily/dnflash/content/oct2008/db20081020_022663.htm?chan=top+news_top+news+index+-+temp_top+story


Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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