Sunday Morning Coffee

Some good stuff in Barron's this week.

First is this assessment of hedge fund manager James Melcher;

"Although he's a believer in the importance of asset allocation, Melcher thinks that security selection has become close to irrelevant -- that there's a greater need for broad market judgment rather than rigid portfolio modeling."

Now keep in mind his returns have been stellar; he was ahead of the S&P 500 by about 80% in 2008 due primarily to knowing what parts of the market to avoid and what parts to short. This is of course the essence of top down management. You may not be much for shorting, I am not, but recognizing when an asset class should be avoided or underweighted, like when demand is unhealthy (US equities) or prices are at all time highs (US treasuries) can make all the difference.

Think about the last two bear markets. Simple recognition that demand for equities was unhealthy (for me this means a breach of the 200 DMA but there are other measures that work) became the most important indicator leading to the most important action that someone could take; reduce exposure. Knowing how much exposure to take off gets trickier but even a little reduction would have helped many people.

This takes me to the comment I cited in this week's video where the reader seemed to conclude that with Yardeni (and he is not alone) saying the bottom is in and Roubini (he is not alone either) saying there is more downside to come the best course is buy and hold.

For some people buy and hold was, is and will always be the best course of action. That is not right for me, not how I write this blog and most importantly not how I manage money. So if you are one of the people continually leaving comments that seem to say buy and hold is the only way to go I will say that the market warned what was coming as I noted in this post from December of 2007 that recaps what I believe are the typical warning signs.

Bear markets typically start the same way; the 200 DMA gets breached shortly after the peak, the market goes down a small amount three months in a row (2% rule) and most of the pundits tell us not to worry. All of these things happened in December of 2007 (and November of 2000 for that matter). This was not a prediction it was knowing what to look for based on how these things work. I had been saying the same thing about what the warnings would be for years; here is a post from November 2004 that says the exact same thing.

Buy and and hold is perfectly valid but the insinuation that it is the only way for everyone is not valid.

The other Barron's snippet I wanted to mention was the following about CalPERs;

"Facing its worst underfunding in more than 20 years, CalPERS is rethinking its asset-allocation models. It might even change its view of "alternative" investments, such as real estate, hedge funds and private equity. That would be important, because CalPERS has been a lead goat in a multidecade dispersal of employees' and universities' wealth into those alternatives."

Having too large a percentage in illiquid alternative assets has come around to bite many big endowments and pensions during the bear market. I have been a big believer in alternative asset exposure for quite a while, have written many posts to try to explore the concept and believe a modest exposure can improve the risk adjusted result. As is the case with all "sophisticated" investment tools too much becomes risky and eventually has big consequences.

Many clients have two open end mutual funds that are in the long/short segment and the two funds total maybe 5% of the portfolio. I view commodities in a similar manner with most clients having 3-5% spread between gold and agriculture. The line between diversifier and big bet may not be so thin but it is subjective. While I could probably go a scosh heavier I know I do not want to exceed 10% in these sorts of things because when the do have a bad run, which may not be very often, they get crushed.

What a day for sports yesterday. Virginia v Maryland went 7 OTs in lacrosse, North Dakota v UNH hockey was pretty good and how about Nova taking down Pitt, wow.

My wife is heavily involved with dog rescue. She got this shot of Merlin who is obviously a Basset Hound at yesterday's adoption event. Just seeing that blue toy lit him up with excitement.