How to Recover From the Bear Market
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. Editors Note – The Fed Bails Out Insurance Companies
2. The Case for Aggressive Allocations
3. Third Day Advisors
4. Scotia Partners
5. Combining Both Programs
Editor's Note - Bailouts for Insurance Companies
Just hours after I sent you last week's E-Letter which alerted you to the serious financial troubles among the nation's largest insurance companies, the Treasury Department announced that TARP bailout monies will now be available for insurance companies. As I indicated, the insurance companies have desperately lobbied for bailouts, and now it looks like they will get them, at least for those that have recently bought up banks or other chartered financial institutions to qualify. I can't say I'm surprised.
Stay tuned as your insurance company may soon be controlled by the Obama administration, along with the banks, General Motors and who knows what else will follow.
When you write a weekly E-Letter such as this one that goes out to over one million people, you can expect to get criticized from time to time. After all, people who disagree are more likely to respond than those who agree and appreciate the information provided – nothing new about that – especially since some of my weekly commentaries are devoted to political issues which are almost certain to draw responses from those who disagree with my conservative views.
Recently, however, I have received some criticism from a few readers regarding the fact that I include discussions about the investment programs that my firm recommends in these E-Letters. This comes as somewhat of a surprise, since this E-Letter is provided free of charge, and no one is forced to read it. Still, some readers insist that I should not write about the investment programs I believe in, as to them it somehow taints the integrity of the E-Letter.
I could not disagree more, especially given that we have just witnessed one of the most severe bear markets in history and two bear markets in less than a decade. The active management investment programs I recommend have served to significantly reduce losses in this bear market, and thus they are more relevant than ever. I can only guess that the criticism is coming from those who don’t want to be reminded that their buy-and-hold, low fee portfolios were recently gutted (50% or more) by the Bear Market Express.
This aversion to investment topics may also be indicative of how so many have been misled for so long, and feel they must now stay the course and hope that the market returns to its historical norms. They may make adjustments to their overall portfolio but, as I see it, this is tantamount to rearranging the deck chairs on the Titanic. Of course, everyone is entitled to their opinions.
My firm, on the other hand, is offering a lifeboat to those mired in the clutches of buy-and-hold strategies that have not only failed to meet their investment needs, but in many cases, have resulted in huge losses that have pushed investors even further away from their eventual goals. The reason I mention the investment programs we recommend is that I firmly believe that they offer a viable alternative to some of the failed buy-and-hold strategies that have been so prevalent in the marketplace for many years.
Apparently, many of you are coming around to my point of view regarding active investment strategies that have the flexibility to move to cash or hedge long positions in bear markets. We were pleasantly surprised when about 300 of you who read this E-Letter registered for our March 25 Webinar with Scotia Partners and hundreds more have viewed the recorded version on our website since then. And we have seen the largest influx of new clients and new money in many years in just the last 3-4 months, sadly thanks to the bear market.
Even some mainstream financial advisory firms are now dipping a toe in the active management waters. I am amused at some of the commercial ads that urge investors to come in and visit with an investment counselor to learn of “new” strategies for the current market. In all likelihood, you’ll learn about some of the same strategies I’ve been recommending for almost 15 years.
So, let it be known that from time to time I will continue to discuss how active management strategies can fit into your portfolio. This week, I will revisit two of the money managers that we recommend. You can either read on and see how these two managers have made money this year, despite the bear market, or settle back in your buy-and-hold deck chair and disregard the remainder of this week’s E-Letter. It’s your choice.
Aggressive Programs May Help Recovery
As I have mentioned many times in this E-Letter, the goal of basic active management is to attempt to move to cash in down markets to reduce portfolio risk. However, some investors seek out programs that use leverage or can go both net long and net short in the market for the aggressive portions of their portfolios.
In such programs, the potential for profit (or loss) exists no matter what the market’s direction. As I have written before, I characterize this type of program as being one where the best defense is a good offense. Unfortunately, many of these programs are available only to wealthy investors through hedge funds.
Fortunately, there are aggressive investment programs that are open to virtually any suitable investor. In light of how many retirement portfolios have been decimated by two bear markets in less than a decade, even moderate investors may want to consider having an aggressive investment or two in their overall portfolio. Of course, these allocations should be only a small portion of the assets, but it IS possible to include small allocations to aggressive investment programs and still end up with an overall moderate-risk portfolio.
With that in mind, I’ll spend the remainder of this E-Letter highlighting two aggressive money managers that you have previously read about in these pages. In the discussion below, I’ll briefly summarize the strategy employed by each manager as well as update their performance information.
After that, I’ll show how a combination of these programs might be a viable alternative for aggressive investors who want to diversify their portfolios by including two leveraged, long/short active management strategies. If you would like to learn more about active management strategies in general, see the link to my Absolute Return Special Report in the Conclusion section below.
Third Day Advisors Long/Short Programs
Back in January of 2005, I first introduced Third Day Advisors and its founder, Ken Whitley. The original Third Day program we recommended was the Aggressive Strategy, which allowed aggressive investors the ability to have a leveraged long and short exposure to the Nasdaq 100 Index. Over time, Ken has applied his signal to other market indexes, but all are based on the same underlying trading model.
Ken’s money management strategy is a proprietary blend of momentum, trend-following and overbought/oversold indicators. There are ten basic indicators that Ken uses to analyze the market, with a number of sub-indicators that also factor into each trading decision. Each indicator “votes” on whether to be long, short, or neutral in the market. The model is 100% mechanical, though Ken does reserve the right to override his system’s signals in the case of a national emergency.
Depending upon the market index, Third Day selects among index mutual funds available from the Rydex family of mutual funds. These funds are part of the Rydex Dynamic class of funds that seek to provide investment returns that correlate to 200% of the daily performance of the underlying index. Separate funds are provided for positive and negative (inverse) correlations.
The Third Day investment strategy does not currently employ any traditional stop-loss techniques to automatically exit losing trades. To limit risk, Ken varies his allocation based on the relative strength of his trading signal and market volatility. As a general rule, his allocations may range from a low of 15% to a high of 100% of the account value, depending upon the program. However, maximum allocations are rare and Ken’s various programs are projected to be in cash (money market fund) an average of 42% of the time in any given year based on historical performance.
The lack of a formal stop-loss trades and frequency of trading are additional reasons why Third Day’s investment programs should only be considered for the aggressive portion of an investor’s portfolio, where high volatility and significant periodic drawdowns can be tolerated.
Both the Third Day Aggressive Strategy and S&P Plan have turned in strong performance so far in 2009. As of the end of March, the Third Day Aggressive Strategy posted a gain of over 13% for the first quarter of 2009, while the S&P Plan gained 11.20% over the same period of time. This is even more impressive when compared to the S&P 500 Index which was down over 11% (including dividends), even after an impressive March rally. Of course, past performance is not necessarily indicative of future results.
The Third Day Aggressive Strategy has the longest track record of all Third Day programs with actual trading beginning in November of 2001. This strategy trades the NASDAQ 100 Index, which is often seen as a proxy for the high-tech market sector. Over the course of our experience with this program, we have seen that the heavy high-tech weighting of this particular stock index results in it sometimes deviating from the direction of the overall market. Therefore, investors who elect the Aggressive Strategy should do so with the knowledge that it may be more of a tech sector program than one that is based on the broad market.
In light of the tech sector concentration in the Nasdaq 100 Index, Third Day also began to apply its trading signals to other market indexes. In 2006, the Third Day S&P Plan began actual trading. After watching its performance for a while, we began recommending it to our clients who wanted an active management strategy based on more of a broad-market stock index. Though the S&P Plan had a shorter actual track record than the Aggressive Strategy at the time, we were comfortable recommending this new program because we knew it was traded based on the same signal that Ken Whitley had been producing since 2001.
The actual performance information below provides detailed monthly returns and time window analysis for both the Aggressive and S&P Plan programs. This format will help you to more easily compare the two Third Day programs based on their actual performance. Keep in mind that all of the performance information shown is net of management fees and expenses.
Please see Important Notes at the end of this E-Letter.
As you evaluate Third Day’s performance, it should become clear to you that Ken’s Aggressive Strategy performed much better in the 2000 – 2002 bear market than in the most recent market downturn. Based on our research, we feel that this difference is largely due to a “disconnect” between the tech-heavy NASDAQ 100 Index and the broad market stock indexes.
Third Day’s S&P Plan, on the other hand, was better able to maintain more value during 2007 and 2008 than the Aggressive plan, again owing to the fact that this program is based on the broad market S&P 500 Index rather than the NASDAQ 100 Index. Remember, however, that past performance is not necessarily indicative of future results.
While we would like to have seen the S&P Plan pick up more gains from inverse (short) trades during the worst of the bear market, we have realized that Ken’s trading model is not as adept at handling high-volatility markets as are other programs, such as the Scotia Growth S&P Plus Strategy that I will discuss below.
However, we feel that the Third Day S&P Plan may be a good alternative for the aggressive portion of your portfolio when the market eventually bottoms out and volatility decreases. Also note that both the S&P Plan and Aggressive Strategy have posted double-digit gains as of the end of March. Past performance, however, does not guarantee future results.
The minimum investment for the Third Day program is $50,000 and it is custodied at Rydex Investments. You can obtain more detailed information about Third Day’s strategy and performance on our website at the following link:
At this link, you can also learn about an even more aggressive Third Day program called the Ultra Aggressive Strategy. This program also trades the tech-heavy Nasdaq 100 Index, but does so with trade allocations that can be as high as 100% of the account value. As always, read all descriptive and disclosure information on these programs before deciding to invest.
Scotia Partners – Riding the Waves of Volatility
As I mentioned earlier, Third Day’s investment programs experienced difficulty when faced with the high volatility that has characterized this bear market. Scotia Partners’ investment programs, on the other hand, have seemed to almost embrace the increased volatility, performing much better in the bear market than during the previous rally phase of the market.
In 2008, the Scotia Growth S&P Plus Strategy gained over 77% net of fees and expenses, when the S&P 500 Index fell 37%. So far in 2009, the Growth S&P Plus Strategy has posted a gain of over 28% as of March 31, while the S&P 500 Index is still under water. Since its inception in August of 2004, the Growth S&P Plus Strategy has produced an annualized return of 38.83% as of the end of March, while the S&P 500 Index can muster only a negative 4.76% over the same time period. Past performance, however, cannot guarantee future results.
Based on our daily monitoring of Scotia’s performance and trading, we feel that its success has come largely due to portfolio manager Cliff Montgomery’s trading strategy that seeks to trade only on those days that offer the best statistical probability of success. Otherwise, he’s content to sit on the sidelines in the money market awaiting the next opportunity.
Scotia’s Growth S&P Plus investment strategy is a combination of two proprietary trading models developed by Scotia’s owner, Cliff Montgomery. The objective of the strategy is to provide positive returns regardless of market conditions, with significantly reduced risk due to limited market exposure. Of course, there are no guarantees that Scotia can continue to achieve this objective.
Using technical analysis, the basic model seeks to determine a long-term market trend (6-12 months) for the S&P 500, which then sets the overall direction for any trades. Once the long-term trend is identified, the intermediate-term trend is then determined using similar analysis. Only when the intermediate and long-term trends are in agreement will the basic model issue a trading signal.
With the overall market trend identified, the basic model looks for short-term movements against the trend. In other words, the strategy seeks to take advantage of the possibility of a “reversion to the mean.” Cliff’s model views a contra-trend market movement as an opportunity, since future market action should move back in line with the overall trend. Thus, Cliff describes his model as being trend-following in the long term, but contrarian in the short term.
In addition to the basic trading model, the Scotia’s Growth S&P Plus program also incorporates a proprietary overbought/oversold indicator that overlays the basic model. This added signal seeks to identify long or short trades that have a high probability of success, without regard to the direction of the long-term trend indicator. Accordingly, this overlay generally results in more trades per year than would be possible under the basic model.
The Growth S&P Plus Strategy is exceptional in that it has historically been in the safety of a money market account over half of the time and trades only on days when Cliff’s proprietary strategy indicates chances are optimal for a gain. As I have said in the past, this is one of the most interesting trading strategies I have ever seen, and it has certainly done extremely well in a market environment reeling in the wake of the subprime/housing meltdown. Remember, however, that past performance does not guarantee future favorable results.
Like the Third Day programs, Cliff’s methodology is 100% mechanical with no discretionary input, and no provision for Cliff to override any trading signal. However, unlike Third Day, the Growth S&P Plus Strategy does not make graduated or partial investments. Instead, the model will be 100% long in the Rydex S&P 500 2X Strategy Fund, 100% short in the Rydex Inverse S&P 500 2X Strategy Fund or 100% neutral (money market), depending upon the signal.
Because of the selective nature of the trading models, the Growth S&P Plus Strategy has historically been in the safety of a money market fund approximately 65% of the time. Scotia does not employ any formal stop-loss techniques to limit risk other than the relatively short duration of trades. If a trade makes money, the model automatically retreats to cash. If a trade loses on its first day, the model may stay long or short for an additional day. However, if even one indicator disagrees with the others, the model exits the market and goes to cash.
The performance information below tells the whole story. As you review this information, again remember that all numbers are actual returns and are net of fees and expenses, and that past performance cannot guarantee favorable future results.
Please see Important Notes at the end of this E-Letter.
As you evaluate Scotia’s performance, you see that its performance has increased dramatically since mid-2007. If you superimpose a graph of the CBOE Volatility Index (VIX), you will find that Scotia’s jump in returns coincides with a big jump in market volatility, as measured by VIX.
Initially, we thought that this might be an indication that Scotia’s programs were somehow “short-biased,” meaning that they entered into predominantly short trades, which would be favorable in a bear market. However, such a bias would be detrimental in a bull market, so we analyzed the individual trades to determine if there were any bias patterns. Our findings were significant:
As you can see, there were actually more long trades than short trades, and a higher number of long trades were successful. The conclusion to be drawn is that Scotia’s Growth S&P Plus Strategy does not appear to have any specific long or short bias. However, because of the increased volatility generally associated with bear markets, such periods have the potential to produce greater relative performance than bull market periods.
The minimum investment for the Scotia Growth S&P Plus Strategy is $25,000 and funds are also held at Rydex Investments. You can obtain more detailed information about Scotia’s programs, including a less aggressive option known as the S&P Moderate Growth Strategy, on our website at the following link:
As I noted above, literally hundreds of my readers have heard Cliff Montgomery personally explain the specifics of Scotia’s money management strategy via our recent webinar. If you missed it and would like to watch and listen to the full webinar discussion (including all charts), click on the link below:
A Combination Approach
As you have no-doubt observed as you reviewed the above performance information, returns in any given time period can be significantly different – even among aggressive investment alternatives that are traded in a similar manner. Third Day’s Aggressive program did better than Scotia during some years in the up markets between 2003 through 2006, but not in others. Scotia has outperformed Third Day during the volatile bear market that began in 2007, but who knows how long this increased volatility may last?
If we had a crystal ball and could know exactly what kind of market environment to expect in the coming months and years, it would be easy to determine which of these programs to include in your portfolio. However, since we don’t have a crystal ball and most of the “experts” have been horribly inaccurate in their forecasts of what market conditions to expect, we have to find another way to take on the possibility of changing market environments.
If you feel that Scotia and/or Third Day would be suitable for a portion of your portfolio and are within your risk tolerance, I suggest that you consider combining the two programs within your aggressive portfolio allocation. While the past performance of these programs cannot guarantee success, we have seen that each has shown the ability to excel during certain types of market environments. Plus, these programs are not correlated with each other, with an R-squared value of only 0.02.
I would like to be able to provide a hypothetical illustration of these two programs together, but the disclosures necessary to do so would be too onerous in an already long E-Letter. Suffice it to say that, in some cases, combining programs can produce a smoother performance with lower drawdowns. While it’s granted that no combination would outpace Scotia’s recent performance, it is also important to realize that no market environment lasts forever, which is why it’s important to have a combination of programs in a diversified portfolio.
While it is difficult in this E-Letter setting to illustrate a combination approach, you can get an idea of how a combination of these two programs would behave by contacting one of our Investment Consultants at 800-348-3601 or by e-mailing email@example.com. Plus, our Consultants can also show you how to incorporate less aggressive actively managed programs into your portfolio.
I hope that by now you have seen that allocating a percentage of your portfolio to aggressive investment programs may help you to recover from the ravages of the bear market. Just keep in mind that aggressive allocations are not suitable for everyone and that such allocations should be kept to a small percentage of the overall portfolio, especially for moderate-risk investors. Never take on more risk than you should in an attempt to quickly recover all of your investment losses.
If you would like to receive more information about any of the programs I have discussed this week, give one of our Investment Consultants a call at 800-348-3601 or e-mail us at firstname.lastname@example.org. You can also request information via our online request form. We also have other programs more suitable for less aggressive investors, so be sure to ask about them as well.
If you would like to learn more about active management strategies in general, I invite you to download my Absolute Return Special Report. This informative document explains the difference between active and passive management in much more detail, and also provides expanded descriptions of active management strategies you may want to consider for your own portfolio.
I hope that my discussion of the various actively managed programs available to you through my company is of benefit to you. I realize that some may not be in a position to invest right now, but it’s still important to know about these strategies for the future. We sometimes get calls from long-time readers who suddenly find themselves the recipients of a retirement plan rollover, inheritance, proceeds from the sale of a business or other large lump sum and are glad that they learned about active management before they had the money to invest.
In closing, I want to make it clear that my comments regarding complaints are not in any way an indication that I do not appreciate your feedback. I and my staff go over every response generated by my E-Letters, and I always appreciate your thoughts, concerns and questions. However, in regard to discussing the active management strategies we recommend, I feel it necessary to be outspoken for a number of reasons.
First, I feel that these strategies embody some of the best active managers in the country, and all have undergone our strict due diligence review before being recommended. Second, my firm has been evaluating and recommending active money managers for close to 15 years, so we’re not the new kids on the block. Keep this in mind when your buy-and-hold broker has a sudden revelation about active management strategies.
A final reason that mentioning these programs is important is that the financial media are now catching on that investors are leaving buy-and-hold strategies in droves. In some respects, that’s good. However, it also concerns me because some investors may become the victim of scam artists or enter into investments they don’t understand, all for the promise of making up all of their losses.
It’s a dangerous world out there for the investor, and there is no shortage of individuals who would be more than happy to separate you from the remainder of your nest egg. Therefore, to the extent that I can prevent that from happening, I feel it is my duty to do so and I make no apologies for it. As always, please read the Important Notes and disclosures that follow my signature below.
Offering hope for investors bitten by the bear,
Gary D. Halbert
IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM), Scotia Partners, Ltd. (SPL), Third Day Advisors, LLC (“TDA”) and Purcell Advisory Services, LLC (PAS) are Investment Advisors registered with the SEC and/or their respective states. Information in this report is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. HWM receives compensation from PAS and TDA in exchange for introducing client accounts. For more information on HWM, SPL, TDA or PAS, please consult Form ADV Part II, available at no charge upon request. Any offer or solicitation can only be made by way of the Form ADV Part II. Officers, employees, and affiliates of HWM may have investments managed by the Advisors discussed herein or others.
As benchmarks for comparison, the Standard & Poor’s 500 Stock Index (which includes dividends), the NASDAQ Composite Index and the NASDAQ 100 Index represent unmanaged, passive buy-and-hold approaches. The volatility and investment characteristics of these benchmarks may differ materially (more or less) from those of the Advisors and these Indexes cannot be invested in directly. The performance of the S & P 500 Stock Index, the NASDAQ Composite Index and the NASDAQ 100 Index is not meant to imply that investors should consider an investment in these trading programs as comparable to an investment in the “blue chip” stocks that comprise the S&P 500 Stock Index or the stocks listed on The NASDAQ Stock Market that comprise the NASDAQ Composite Index or the 100 NASDAQ stocks that comprise the NASDAQ 100 Index. Historical performance data represents actual accounts in programs named Scotia Partners Growth S&P Plus, Third Day Aggressive Plan and Third Day S & P Plan, custodied at Rydex Series Trust, and verified by Theta Investment Research, LLC. Since all accounts in these programs are managed similarly, the results shown are representative of the majority of participants in each of these programs. The signals are generated by the use of proprietary models developed by Scotia Partners and Third Day Advisors with the objective of participating, on a leveraged basis, in trading days with the highest probability of success. Statistics for “Worst Drawdown” are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Mutual funds carry their own expenses which are outlined in the fund’s prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.
When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results. The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to these trading programs.
In addition, you should be aware that (i) these programs are speculative and involve a high degree of risk; (ii) the trading programs’ performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in these programs; (iv) Purcell Advisory Services (for Scotia) and Third Day Advisors will have trading authority over an investor’s account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the trading programs’ fees and expenses (if any) will reduce an investor’s trading profits, or increase any trading losses.
Returns illustrated are net of the maximum management fees, custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. Management fees are deducted quarterly, and are not accrued on a month-by-month basis. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. No adjustment has been made for income tax liability. Dividends and capital gains have been reinvested. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.
Copyright © 2009 Halbert Wealth Management, Inc. All Rights Reserved.
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.