Daily State Of The Markets: Understanding The Game Being Played

by: David Moenning

Publishing Note: In an effort to recharge the batteries for the coming year, I am going to take a few days off from the early morning routine. Thus, I will not publish Daily State reports next week unless conditions warrant.

Good Morning. I don't know about you, but I really enjoy this time of year. Obviously the time with family is the highlight during the holidays. But I'm guessing you don't need me to tell you that. So, what I'm really referring to here this morning is this is the time of year when you review your positions and plot your strategy for the coming year in the markets.

I'm of the mind that it is always an enlightening experience to take a look at things that worked out as well as those that didn't. While it may be painful for many to spend time rehashing what didn't perform, this is actually one of the best learning experiences there is in this business. It is important to recognize that just because a holding or a strategy didn't make money doesn't mean the strategy failed. Remember, there is no strategy on earth that performs in all environments year in and year out.

Sure, there are some things that come close. But even the tried and true strategies fall flat on occasion. Thus, it is important to identify what went wrong. For example, was it the market environment that caused the problem (feel free to nod your head in unison here)? Or was the implementation of the strategy the problem? Or worse yet, did you decide to change strategies back and forth as the market went to and fro this year?

When I was responsible for doing due diligence on mutual funds for a brokerage firm in the late 1980's, I tried to stress to folks that the bottom line result isn't always the bottom line. You see, I feel it is important to understand the strategy a manager utilized and then compare how he/she did relative to how that particular strategy performed.

Let's use 1999 as a rather obvious example. While a 30% return may have looked like a stellar result due to the fact that the S&P 500 was only up 21.1%, it would have been a miserable return for anyone using a growth or earnings momentum approach. And if the manager had been tech oriented, well, a 30% gain would have been an abject disaster!

The key is to understand what to expect from the strategy you are employing (and remember, hope is not a strategy). In 2011, there were a host of things that did not work well at all. In short, anything that didn't involve owning a big slug of U.S. government bonds (which at the beginning of 2011 sounded like a very bad idea) probably struggled.

I also find interesting that with just five-ish trading days left on the calendar, the S&P 500 is a single buy program away from being breakeven for the year. Think about that. All the news, tragedy, unrest, and fear has wound up amounting to next-to-no movement in the stock market. Thus, while anyone employing a buy-and-hope approach would have been exposed to a rather violent ride, the end result wasn't bad.

On the other hand, almost any "active" management approach of the markets struggled in 2011. For example, through yesterday, the average hedge fund is down a fair amount year-to-date. The HFRX Global Hedge Fund Index is down -8.48% on the year, the Market Directional Index is off -17.68, the Fundamental Value Index is off -22.78% (I guess those cheap stocks just kept getting cheaper), and even the Absolute Return Index is red, to the tune of nearly -4%. So, while the buy-and-hope crowd had their comeuppance in 2000-03 and again in 2008, traders trying to navigate the stormy seas of the past year probably got caught on the wrong side at one point or another.

So, does this mean that investors should abandon an active management approach? After all, that "management" wound up costing investors money this year. Should the public simply give up on trying to manage risk and return to the mutual fund industry's beloved buy-and-hope strategy? (For those of you keeping score at home, the Lipper Growth Fund Index is down -27.9% since 12/31/1999). In a word, no.

The bottom line is that 2011 was a very unique and very difficult environment. And unless you think that the stock market is going to move up and down 8% every 5-10 days next year, giving up on risk management is just plain silly. In my humble opinion, the best thing an investor can do going into 2012 is to fully understand the strategies they are implementing and then continue to monitor their progress against how that type of strategy should be performing.

Turning to this morning ... Santa appears to be arriving as scheduled this year as overseas markets were higher overnight and U.S. futures are also in the green in the early going.

On the Economic front ... The Commerce Department reported that Durable Goods orders were up +3.8% during the month, which was better than the consensus expectations for +2.5%. When you strip out the volatile orders for transportation, orders rose by +0.3%, which was in line with the consensus for +0.3%.

Next up, Personal Incomes rose by +0.1% in November, which was below the consensus expectations for an increase of +0.2%. Personal Spending (now called “Consumption”) for the month rose by +0.1%, which was below the expectations for +0.3% and even with the October reading of +0.1%. The Core PCE (think inflation) came in with a gain of just +0.1% which was in line with expectation for +0.1%.

In addition, we will get a report on New Home Sales at 10:00 am eastern.
Thought for the day ... I'd like to wish everyone a Happy Holiday season!!
Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell ...
  • Major Foreign Markets:
    • Australia: +1.20%
    • Shanghai: +0.85%
    • Hong Kong: +1.37%
    • Japan: -0.75%
    • France: +1.07%
    • Germany: +0.32%
    • Italy: +0.35%
    • Spain: +0.94%
    • London: +1.02%
  • Crude Oil Futures: +$0.29 to $99.82
  • Gold: -$0.40 to $1610.20
  • Dollar: higher against the yen, lower vs. euro and pound
  • 10-Year Bond Yield: Currently trading at 1.944%
  • Stock Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: +6.20
    • Dow Jones Industrial Average: +44
    • NASDAQ Composite: +4.7
Positions in stocks mentioned: None