In Part I of this article
, I showed the results of buy-and-hold versus intermittent
rebalancing for 2008 and 2009, a period when we made horrible
re-balancing decisions (and still came out ahead of buy-and-hold.)
Now here are a couple actual examples of fair-to-middling good
If you look back to the inception of our model portfolios, 1999,
our re-balancing discipline left us with:
- a 2% lesser return that year than the S&P (21.8% to
- in 2000, our re-balancing discipline left us with a 25%
greater return than the S&P (minus 10.1% to our
- to 2001, a 20% larger return than the S&P (minus 13% to
- to 2002, a 30% larger return than the S&P (minus 23.3% to
Clearly, re-balancing to avoid at least some of the market's
downturns was a good thing to have done. In 2003, the market picked
up and enjoyed a good run until 2007. Not a lot of need to
re-balance when the fish are running your way. But during
less-settled times? I believe intelligent re-balancing will beat
buy-and-hold (as well as day-trading) in order to finish far ahead
of the madding crowd.
Of course, markets can remain overvalued and climb even more,
making re-balancers wish we had held on longer. Or they can become
severely undervalued and make us wish we had waited another couple
months before initiating positions. But we're usually talking a
couple to at most a few months. No honest analyst will tell you he
or she can "time" the market. We don't try. If, however, we can get
to within a few weeks or months of a bottoming area by studying the
geopolitical and economic environment, current events, PEs, yields,
PSRs, book values, and investor sentiment, we've done what we set
out to do.
Let me be clear: I am a long-term bull, and long-term bulls are
often buy-and-hold types. I would like to be. But that would be the
triumph of hope over experience. Still, 40 years of personal
experience and a deep and close study of the previous nearly 200
years convince me that it is folly to bet against the long-term
resiliency of the American economy and the American people.
Yes, we are sometimes (OK, often) led by idiots. (But we are the
ones who elected them!) Yes, we sometimes shoot ourselves in the
foot. But bet against the world's most innovative people with the
finest draw for citizens of every other nation to come here to work
and live? That would be lunacy. So while we re-balance to
our exposure to US markets, we are never 100% in cash or 100% out
of the US markets.
There are times when we are only 10% in cash, but also only
10%-20% in US markets, with the rest in other developed and
developing markets. But even in the worst of expected times, we do
not have the arrogance to see the US economy, and therefore US
markets, as down for the count.
I know many people believe "It's different this time! Our
troubles are far worse than ever before!" I heard the same thing
when interest rates hit 21.5% (actually, the
hit 21.5% -- other rates were higher) as a result of the terrible
decisions made in the late 1970s. My parents heard the same thing
during The Great Depression. I believe you will go broke shorting
America. Americans bounce back.
As a result, we merely re-balance our model and client
portfolios -- we do not panic about the demise of civilization as
we know it. All the nay-sayers had their day in print but they
neglected to count on the resiliency of the American people and the
flexibility inherent in an economic system that rewards
entrepreneurialism and innovation.
I happen to believe a short-term decline is the most likely
This is an unusual call
because, typically, coming into a new year the markets are filled
with hope and new money from year-end bonuses, raises, COLA
increases for Social Security, and so on.
But this is a market that has come from 6,600 to 10,600 with
hardly a pause along the way. Valuations have returned to levels
that suggest a correction. Without taxpayer stimulus to buy cars
and houses, auto sales and home sales are returning to recessionary
levels. Portugal, Italy, Ireland, Greece and Spain are scaring
investors with their possible inability to repay their debt. And
investor sentiment is nervous as a cat on a hot stove.
I think it's time to re-balance for protection. If I'm wrong, I
don't see it hurting us much -- I don't see any catalyst on the
horizon that might propel the markets from 10,400 up more than
7-10%, which would take us to 11,000 or so. I do see a number of
scenarios, however, where a normal correction of 15-25% would
Missing 1,000 points on the upside would hurt our
-- but we could easily recover from it merely by exceptional asset
class, sector and/or stock selection. Losing 1,500 to 2,500 points
on the downside, however, would be devastating to our
. Heck, losing the same 1,000 points on the downside would be
scarifying, especially after the terror ride of 2008 and 2009. So
if protection of capital means short-term under-performance, I see
it as a good choice. Protecting capital is the step
Please don't mistake our brand of re-balancing with those who
re-balance based on a particular technical timing signal or others
who re-balance based upon a mechanical schedule : once a year,
twice a year, four times a year, always on the same date. Those
types of re-balancing will still often produce better returns than
buy-and-hold, but they are too "mechanical" for us.
Ours is based, instead, upon our read of external events (sovereign
nation debt fears, a collapse of the housing market, etc.),
valuation (is the market cheap or dear based upon yield, prices
relative to earnings, book value, sales, etc.), investor sentiment
(are investors skittish or confident, ready to pounce on any
concept or ready to sell based on this morning's news, etc.) and
what our experience in the market and proximity to its rhythms
indicate to be the Right Thing to do right now. None are flawless.
All taken together have allowed us to stay comfortably ahead of the
One final thought: I find, even in light of demonstrated
superior performance, there remains one common roadblock to
re-balancing: people confuse great companies with great stocks.
There's no question in my mind that Mr. Buffett's favorite
companies, like Coke (
), AmEx (
) and Wells Fargo (
), are fabulous franchises. All have big moats around them, are
difficult for new brands to steal market share from, are
better-managed than most of their peers (no great feat for Wells in
banking), attract good talent, and will continue to grow their
earnings in future years. But so what?
If you fall in to the trap of thinking a great company means you
should hold their stock through thick and thin, you have made such
an amateurish mistake that you should not be surprised when your
) goes from 55 to 3 or your [[GE]] from 60 to 6 -- or your Coke,
AmEx or Wells to single digits or low teens, for that matter.
Great companies are sometimes valued below where their
long-term prospects would indicate they should be, and they are
sometimes valued above where their long-term prospects would
indicate they should be
. You are not being "disloyal" or wishing the company that employed
you for 30 years ill just because you sell their stock!
Try to think of stocks as what they are -- pieces of miniscule
ownership that allow us to go along for the ride during periods
where a particular company's share price goes from undervalued to
overvalued. The company raised its money in an IPO. They already
have that money. Unless there is a secondary offering from the
company, not merely insiders dumping into less-suspecting hands,
your purchase is from a third party, either an institution or an
individual. If you want to show fealty to the company, you'd do
better to support them by buying one of their toothbrushes or razor
blades or lawn tractors or whatever it is they sell. You aren't
buying from or supporting the company by holding their stock.
Stocks are liquid securities that trade among individuals with
different viewpoints as to their future prospects.
I am personally convinced that something like 40-50% of a
security's appreciation is because the market itself is
appreciating (hence we re-balance to stay in tune with the market),
another 20-40% is based on how favorably that asset class and/or
sector are viewed (hence our emphasis upon big sector themes) and
only another 20% or occasionally a little more based on some
exceptional factor with that company (hence intelligent stock
selection as the final leg of our three-part approach). If you
agree with this logic, then you cannot believe you should hold a
particular stock through any and all market environments. Be
flexible in recognizing that there are good markets and bad, good
times to be a buyer and good times to be on the sidelines.
There will always be special situations in which to place a few
dollars, even in a market that is correcting. Among those we have
purchased for our model portfolios is the iPath S&P 500 VIX ETF
), which is basically a play on the volatility of the market. Since
most people will wait to sell until all others are selling, we're
betting that there will be a waterfall effect of selling and that
volatility will rise -- and that VXX is a smart way to profit from
There's a time to be fully invested -- and a time not to be. We
believe a willingness to re-balance at important decision points
will maximize your net worth
your peace of mind.
: We and / or clients for whom these investments are
appropriate, are long VXX and a substantial cash cushion.
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
Also, 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 did not do so for 2009. We plan to be
back on track on 2010 but then, "past performance is no guarantee
of future results"!
It should not be assumed that investing in any securities we
are investing in will always be profitable. We take our research
seriously, 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.
FOMC: Will They or Won't They?