Winter Letter To Clients [Part I}

Today we begin releasing to the public our most recently investment letter which has already been sent to our clients.

Musings on the Return of an “Old Friend”.

An “old friend” seems to have stopped by for an uninvited and extended stay at Mr. Market’s home these days.  Mr. Market’s housemates though do not universally adore our “friend”.  Traders purport to love him-that is as long as they are in his good graces.  Investors generally loathe him as he often brings to them sleepless nights and churning stomachs.  Our “friend’s” manipulations are little understood by these folks and they just wish he would pack his bags and be off.  Our “friend” usually has a story to tell, but he speaks often in riddles or contradicts himself. Yet if you listen closely to what he brings there is one constant to his muddled views of the world which is uncertainty. 

Our “old friend” is volatility.  He went on vacation somewhere back in 2011, stopped in for a brief “how-do-you-do” in 2012 but then all but disappeared until last fall.  Since then he’s made his presence felt in the equity and bond markets, while most recently bringing havoc on currency traders.  Volatility often brings along his companion “trading range” and this visit is no exception.  With the passage of time we can see that the markets have been locked between roughly 1,820 and 2,080 on the S&P 500.  That’s roughly a fourteen-percentage point zone these two currently are dancing around.  Indeed as of this writing, stocks are only a few percentage points higher than where they traded right before the 4^th of July holiday last year. 

Our “old friend” volatility has returned because of uncertainty in the markets.  While the US economy continues to expand, most of the rest of the world is mired in low or zero growth environments.  Then there’s the two-sided story volatility spins about last year’s unexpected drop in the price of oil.  On one hand he says this is good for consumers globally.  A decline in the amount we’ve seen over the past few months is the equivalent of a global tax cut.  But our friend then says out of the other side of his mouth economics is often a zero sum game.  While consumers benefit from oil’s decline, there is a negative impact on economies dependent on a higher price of oil as well as the incipient fear that the decline is presaging a much slower growth rate world wide than investors are currently forecasting.

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. 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 trendless 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.

Tomorrow Part II.

 **Long ETFs related to the S&P 500 in client and personal accounts.