Spring Letter To Clients {Part III}

Probability also suggests the possibility of higher market volatility going forward.  This should not come as a surprise to our readers.  We covered volatility and the potential for a market decline on back in January   on our blog Solas!.   

“Probability analysis leads me to think that we will see at least one decline this year in the market in the 10-20% range.  It's been a long time since we've seen something like this.  Probability suggests that since normal market volatility is somewhere close to 10%, it is reasonable to suggest that we could revert to the mean at some point this year.”

 We continued this theme in our Winter Letter that we sent to you:

 “I think 2014 has the potential to be a year of growth but I would also note that the last time the market saw a real correction greater than 10% was in the spring and summer of 2011.  Probability suggests that at some point we will see markets decline in excess of that.  Given the hope investors seem to have for stocks this year and given where we stand in regards to market valuations, probability would suggest that we prepare for that sort of decline at some point this year.  Our strategy may be to build up our cash reserves as per individual client risk/reward and strategic mandates as we rebalance accounts.  As always in times like these we will have the defensive pages of the playbook nearby.”

Volatility is the price investor’s pay for liquidity.  It is the reset mechanism that often caps the financial excesses that sometimes can lead to large market declines.  We discussed what usually happens for a crash to occur over on our blog here.  Investors should expect some volatility and should accept that sometimes prices will correct.  Volatility is most often associated with market declines. Volatility can work both ways but presumably investors don’t mind when there is a sharp gain in their investments. Investors though mostly hate volatility when prices head lower, especially when the declines are swift and steep. There are strategies in our playbook that deal with trend less and more volatile periods that we use in our game plan for client accounts. One of the easiest methods to decrease volatility in a portfolio is to raise cash.  Cash is the only way to completely avoid a market decline.  Since it is unlikely that your portfolios will ever be 100% in cash when invested with us this is not complete protection against a bear market.  Put it this way.  If Warren Buffett knows of no way to completely hedge a portfolio then it is probably impossible to do.  The goal when investing is to be aware when the markets are in a lower probability environment, have enough cash that fits into your risk/reward parameters so you can ride out the decline and then be able to deploy that cash when markets begin their next advance.  

**Long ETFs related to the S&P 500 in Client and personal accounts although positions can change at any time.