A Word From The Advisor
Bulls, Bailouts & Fishermen

The fact that we don’t predict the future doesn’t mean that we don’t think deeply about markets and the economy. The Standard & Poors 500 has surged 65% in only nine months, one of the strongest rallies ever recorded. So, what’s an investor to do? Is there still time to jump in, or is this just a giant sucker’s rally about to collapse?

Of the many well-known market pundits, from Bernanke to Buffet, our interest was piqued by a well recognized analyst who identifies four legs which typically support bull markets, namely:

Leg #1: Improving fundamentals, or a “V-Shaped Recovery of the Market Index”: Across the globe, economies are recovering much more quickly than anticipated only six months ago.

Leg #2: Unprecedented stimulus, or “Don’t Fight the Fed”: The Federal Reserve continues printing money in its valiant effort to stave off deflation, with no signs of easing up in the near-mid term. Those dollars have to go somewhere, and the odds are that they will continue to flow into financial assets, pumping up prices.

Leg #3: Strong technicals, or “Don’t Fight the Ticker Tape”: Technical analysts perceive many signs that the bull has room to run, e.g. market breadth – we continue to see the market reach higher highs and higher lows which has confirmed every new price high for the major averages. However, recent price action suggests that the rally may be tiring.

Leg #4: Favorable sentiment, or “The Rally Everyone Loves to Hate”: Investors don’t trust this rally. They either missed it and surmise they are too late to climb aboard, or they are waiting for the other shoe to drop with regard to the economy. While that may be a valid concern for now it seems to be part of a “wall of worry” that the market likes to climb. When investors become euphoric, it’s oftentimes the beginning of the end.

While the weight of evidence suggests that the bull market is still alive, this analysis indicates that the “technical” and maybe even the “sentiment” legs are transitioning from the “straight-up” part of this bull market to a more challenging and volatile two-sided market environment.

The bottom line is that while all four legs remain bullish, they’re not quite as bullish as they were a few months ago. The V-shaped recovery still looks good (although not growing as fast as other recoveries) and the Fed should continue to keep short term rates low, but sentiment is not as compelling as it was earlier in the year. So, this is no longer the “just close your eyes and buy” market of spring and summer. It‘s a more challenging and tactical environment in which there is still upside potential but also more risk. We agree that the rally is sustainable, but this will not be a one-way, upward-barreling market, as increasing volatility will bring inevitable sell-offs. Of course this is to be expected and even welcomed following a 65% run-up over a short time period. This is a market which should reward patient and disciplined investors; short-term speculators are unlikely to fare as well.

We don’t time the market but we are keenly attuned to market dynamics. When we begin to see issues that raise our concern, we pay attention, moderate, and adjust course. One of our favorite metaphors for our approach is that of the fisherman…

The parable of the fisherman

A fisherman preparing for a weeklong excursion naturally consults the weather report. But he doesn’t rely only on a weather forecast to ensure a safe return. Rather, an intrepid fisherman understands that weather is inherently unpredictable and beyond his control. Consequently, he focuses intently on things within his control, by preparing the fishing boat for any potential weather behavior. He undertakes regular maintenance on the hull, the lines, the engines, as well as thoroughly checking all navigation, communication, and safety systems. Most important, he prepares his supply stock, including all necessary tools to make repairs should anything go wrong en route.

At Oakwood, in our quest to deliver attractive risk-adjusted returns over the long term, we undertake preparations uncannily analogous to the fisherman. We understand that we cannot control or predict markets, so we don’t try to. We do, however, check economic trends and financial movements, just as our fisherman checks the weather forecast. And like the fisherman, we focus our efforts on areas within our control. This means constantly monitoring risk/reward tradeoffs, and rebalancing portfolios as the need arises. It means structuring portfolios for optimal tax efficiency. It means minimizing transaction costs. It means remaining vigilant to changes in the weather, and being prepared to adjust course as needed. Above all, it means using our robust set of tools to make necessary adjustments in our investors’ portfolios.

What does this mean for the Oakwood client in 2010?

Uncertainty about the stock market is not unfounded. Fortunately it doesn’t require perfect powers of prediction to prepare oneself for practically any market. In periods of uncertainty, we moderate our investment decisions as we assess whether the stock market will continue to rally through 2010 or retest the lows of last March. As time goes on, we promise that whatever the market delivers, we will emulate the fisherman by applying our best preparation and tools to each client portfolio, in order to maximize your ability to achieve your goals over the long term.

Our nation’s unprecedented bailouts

At Oakwood, we have studied the effects of the unprecedented bailouts our nation has deployed in the one-year period ended March 2009. We provide this chart to illustrate historical comparisons.

In just one short year, the total bailouts managed to surpass the total of nearly every major one-time expenditure in US history, including both world wars (not in graphic), the New Deal, the moon shots, NASA budgets (not in graphic), Iraq, Vietnam and Korean wars — combined!