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Joseph L. Shaefer
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Joseph L. Shaefer is the CEO and Chief Investment Officer of Stanford Wealth Management, LLC, a Registered Investment Advisor. Joe retired as a senior executive at Charles Schwab and Co. to found Stanford Wealth Management, LLC, in 1990. He also spent 36 years in a very different leadership... More
My company:
Stanford Wealth Management LLC
My blog:
The Investor's Edge
My book:
Bringing Home the Gold
  • Seeking Alpha, Finding Zen 8 comments
    May 9, 2010 11:15 PM | about stocks: NRP, PVR, ATLIF, NZTCY, TBT, TIP, NSL, PFL, VXX, VXZ, GG, KGC, FNV, RGLD, SLW

     

    “Alpha” is basically the difference between what “the market” returns and what your advisor, mutual fund, hedge fund, pension fund, brother-in-law or you yourself are able to return for you.  For instance, if the S&P 500 has averaged a 0% compounded return over the last 11 years and one of them / you have averaged an 11% compounded return during that time, their Alpha is 11% per year.

     

    Why is Alpha important to you?  Because it removes the pure luck factor on the part of your advisors.  Without understanding Alpha, you might be quite happy if your advisor or fund returns 8.5% a year compounded for 10 years, considering that a pretty good return that keeps you ahead of inflation. 

     

    But what if a simple index fund, by virtue of being in the midst of a great bull market, averaged 11.5% over that time frame?  Would you still be happy with a manager who over long time periods underperforms the market by such an amount? Why are you paying them to under-perform year after year?  Or what if, in the 11th year, the market plunged 50% -- and your advisor or fund’s performance also plunged 50%?  Would you still be happy with their previous 8.5% a year?

               

    You must allow for the every x year unusual and untoward event!  What you want is an advisor or fund that more often than not beats the averages in up years but is nimble enough to avoid the worst of the down year or years.  That’s why smart investors use Alpha.  It is a measure of how much better your portfolio does in any given month, quarter, year or lifetime than you would have had if you had merely held on to an index fund as a proxy for “the market”  through thick and thin. 

     

    As John Bogle of index fund pioneer Vanguard Funds, and many others, have noted, some 90%  of all active managers fail to beat index funds.  That’s why Mr. Bogle is such an advocate of index funds.  To his way of thinking, why not just ride the market up and ride the market down, since just doing that will beat 90% of the active managers out there?  To my way of thinking, however, the intelligent investor’s quest should be to be among the 10% that beat both the other 90% and index investing.  If I ever retire from this business, I’ll be seeking someone who can also do that. 

     

    Among the smartest ways I know of to stay in that 10% Club is to do things that are not always intuitive.  For instance, we saw the market beginning in 2010 as “priced for perfection.”  The VIX indicator also pointed toward a complacency unseen since the whistling past the real estate graveyard in 2007.  For this reason, we went into cash and income and underperformed the market the entire first 4 months of 2010.  On purpose. 

     

    We chose investments like floating-rate closed-end bond funds rather than chase the latest hot stock.  Our “Alpha” suffered during this time but, then, on a chart like the one below, 4 months does not even show up.  As our firm’s CIO (Chief Investment Officer) I believed the time for hot stocks has passed and that we are ready for a temporary correction within a cyclical bull market within a secular bear market.  Does “correction within a cyclical bull market within a secular bear market” sound confusing?  Maybe this chart will help:

     

     110 yrs Dow

     

     

    If a picture is worth a thousand words, this chart is worth a million.  Giving credit where credit is due, it was constructed by the estimable Sy Harding, one of the smartest technicians I know  and I’ve known a few hundred in my career.  (See Sy Harding’s Street Smart Report, 386-943-4081, well worth the subscription price. You might want to also check out his free daily blog at www.streetsmartpost.com)

     

    “Secular” markets typically last 14-20 years as is clearly visible from the chart above; “cyclical” markets average 6 months to 3 years and are seen as all those ratchets up or down within The Big Move.  “This time will be different” is what market amateurs want to believe, but Sy’s chart of the Dow Industrials clearly shows is that, for over 110 years, the market has behaved in a relatively predictable pattern over the long term. Over the short term, of course, it is eminently UN-predictable, no matter what some slick SPAMmer’s e-mail or direct mail piece may tell you!  (As Ben Graham advised, “In the short run, the market is a voting machine. But in the long run, the market is a weighing machine.”)

     

    Beginning with a secular bear market in the early 1900s, there followed three secular bull markets and three secular bear markets.  I believe, as does Mr. Harding, that we are now in the secular bear market that has followed the rip-roaring, magnificent bull market from 1982 to the end of 1999.  To create your own Alpha and distance yourself from the flock, I believe you may want to consider this possibility, no matter what happens tomorrow or what happened yesterday.

               

    This secular bear began with the dot.com,bom in 2000, went sideways for a couple years, then plunged from 11,300 to 7,500 in one year.  Then, in 2003, the market mounted a fine rally, mostly thanks to cheap government financing that inflated home prices at the same time it kept rates low enough to suck in millions via cheap, if unsustainable, mortgages.  The ensuing rally soared way up to 14,000 and change, before plunging back to 6626, then enjoying a cyclical rally to today’s close -- not even back to its high point of the year 2000.

     

    You’ll note that secular bull markets typically last somewhere between 14 and 20 years.  Those are great times to “buy and hold!”  But since one’s investing lifetime may typically encompass only one secular bull and one secular bear (equaling 32-40 years), most of us miss the long view.  That’s why many investors, who began investing in the ‘80s believe that a secular bull is the norm and the current period is an anomaly.  If so, they may be doomed to lose everything they made in the bull market, by seeing false signs of its return with every cyclical (6-month to 3-year) rally.  Conversely, those who are entering the markets for the first time more recently have seen every rally dashed and are likely to disbelieve the next secular bull market that will come again in a few years.  This is no time to take the short view, including the view of only our first 10 or 20 years in the market!

     

    Now -- look at the chart below, covering just 2000-2010.  In measuring this current secular bear market, you can clearly see periods of cyclical bull rallies, but the chart clearly demonstrates that we have effectively been going sideways since the year 2000.  These cyclical rallies and declines are often well worth participating in.  But our decision to exit at year-end 2009 certainly didn’t hurt us.  After last week, the Dow is right back where it began the year.  And, in addition to making more in interest and dividends than we might have made and lost in capital gains, we slept better at night, too…

     

    The futures indicate that tomorrow will be a monster up day.  Maybe so – but we don’t look at days.  We are looking at where we think the market will be in 6-12 months, not 6-12 days!

     

     

    2000-2010

     

     

    There are two key lessons these charts hold for me:

     

    (1)  Bull markets charge ahead.  Bear markets amble.  Just like the animals chosen to represent them, bulls charge, bears amble.  In the popular mind, bear markets plunge.  But in fact, they are more like resting periods before the next advance, going down, going up, down and up, in a constant game of sideways tug-of-war.  Bull markets, on the other hand, probably because the generation in their peak earning years remembers only the choppy up and down action of the bear they cut their teeth during, surprise them with its strength.  The channel of their upward trajectory is as thin as bear markets’ channels are wide.  This leads me to my second conclusion...

     

    (2) Secular bull markets are profitable periods to buy and hold.  Secular bear markets are only profitable if you are willing to reallocate  your assets from fully invested to less invested and back again.  That’s why, in so many previous articles, I have recommended re-allocating assets to protect your portfolio.  And will continue to…

     

     

    Author's Disclosure: We and / or clients for whom these investments are appropriate, are long NRP, PVR, ATLIF.PK, NZT, TBT, TIP, NSL, PFL, VXX, VXZ, GG, KGC, FNNVF.PK, RGLD and SLW – and still have a very large cash cushion, which we’d love to deploy – at lower prices.

    The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

    Past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but we are flat in 2010.  We plan to be back on track as the year progresses and we put our cash to work but “past performance is no guarantee of future results”!

    We encourage you to do your own research on individual issues we recommend for your analysis to see if they might be of value in your own investing. There are three possible ways you see our work at this site: by your choosing as a result of seeing an article, by taking the recommendation of another reader or, possibly in the future, by being pre-assigned to us because our articles match the interest areas you selected when signing up. In all cases, we take our responsibility very seriously to proffer intelligent commentary, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.

     

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Comments (8)
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  • Joseph: Great article!

     

    I'm not buying into the, "Eureka we solved it," $1T eurozone bailout.

     

    It's a gargantuous bandaid that will only stifle the leaking blood.

     

    Any position I establish tomorrow will have scaple thin stops. If the market continues to go up, I'll raise those stops.
    9 May 2010, 11:50 PM Reply Like
  • Author’s reply » Good plan, Maya. This is an xlnt time for < trailing stops > on those securities that it can be done with...
    10 May 2010, 09:45 AM Reply Like
  • Hey Joseph: Did you take profits on the Vix run-up? What do you think it does from here? And oh....TBT? Love your newsletter.
    10 May 2010, 10:07 AM Reply Like
  • Author’s reply » Thank you, lower98th! Given the user names / handles on SA, I never know which readers here are also subscribers to Investors Edge, but I appreciate your kind remarks!

     

    I couldn't resist taking "some" profits. That was just too pretty a gift horse to take the time to check its teeth too closely. (As if there was time. //grins//) So I sold about 40% of the position and am now playing with considerably more of the house's money. (Good thing, given the slide in VXX today -- which is less about volatility, which we have plenty of, than # of puts vs. calls!)
    10 May 2010, 10:19 AM Reply Like
  • Joseph: Greetings. Excellent article. About as concise an explanation/description of the Bull and Bear market scenarios I have seen.
    10 May 2010, 10:33 AM Reply Like
  • Author’s reply » Thank you, sir! I don't know if you noticed, when selecting a "category," above, in which to place the article, I wrote "US Markets > Market Outlook, and even though it isn't an SA category, it SHOULD be: Market STRATEGY."

     

    I think there are plenty of investors on SA who are interested in strategy, but regrettably the category doesn't exist so articles that don't push a particular point of view ("the govt is crooked, all the numbers, are lies, and we are going to Dow 5000" or "you all better jump aboard this train as it's leaving the station for Dow 15,000," or those touting a particular stock) just don't reach a wide audience -- in this case, only those interested in today's "Market Outlook" or those who already know the author's work.

     

    Yet portfolio construction, laying the foundation, and looking at The Big Picture is what most people really need to do. Ah, well, like Sisyphus, I'll keep pushing this rock up the hill as long as one reader expresses their appreciation as you have!
    10 May 2010, 10:51 AM Reply Like
  • I think you are probably the best columnist on Seeking Alpha. You provide a lot of good, evidence-based insight and are even willing to put out stock picks to back your suggestions. I recently purchased 50 shares each of PVR and NRP after checking out your articles and doing some due diligence (PVR at $20.50 on the big down day last week). Yes, I am really only a small investor.

     

    I wonder what you think of Harry Dent's analysis of demographics data, especially about his predictions of a coming Depression due to the demographic trend of Boomers passing their peak spending years and drawing similarities to the peak spending years of the Japanese.

     

    Also, what do you think of holding physical gold at this time?
    12 May 2010, 03:47 PM Reply Like
  • Author’s reply » Thank you for your kind observations, Hillsfar. What you describe is exactly what I strive to do. It's nice to hear that I occasionally reach that goal!

     

    There is no question that, to some extent, "demographics is destiny." But demographic data is subject to interpretation and some do a better job there than others. I think I should simply let Mr. Dent's analyst's previous track record, for good or ill, speak for his ability to divine the future...

     

    As for holding physical PMs -- I don't, to any significant degree, but I know many who do. If you agree with them, be prepared to pay to have it stored, be prepared to have absolute faith that the organization storing it will (a) be there and (b) give you your property upon request or, if storing it at home, that no one knows and that you are well-armed. I see a decline in the US dollar, not The Apocalypse, so I hold the physical metal in Canadian bank vaults via closed-end funds like CEF.
    13 May 2010, 11:49 AM Reply Like
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