Happy Halloween

Sadly there are now no little ghouls or goblins living at our place any more but we'll wish all the others on our street a fun, and pleasant day tomorrow!

Happy Halloween to all the little ghosts, witches, Olafs and Elsas on Ashland Avenue and to everybody else as well!

****Long candy  And good times! 

Recent Investment Commentary {Conclusion}

Of course irrespective there are certain things you should always be doing.  Below I’ve listed and highlighted a few basic concepts we think all investors should think about.  

Develop a long-term game plan that takes into account all of your net worth.  These include: investment accounts, retirement plans, insurance, real estate, etc.  You should have an asset allocation based on your own personal risk/reward criteria.  If you are investing by yourself then you need to do some research about how your investments are deployed.  You also need to have a realistic conversation with yourself about how much risk you can stomach.  How much risk you are willing to accept is something only you can answer and it may change at different stages of your life. Your plan ought let you sleep at night and ought to give you some idea of what might happen when the next bear market arrives. If you work with an advisor then you need to make certain that both of you are on the same page regarding allocations, risk and goals.

Within the framework of that overall allocation you need to understand how you are invested.  How is your portfolio constructed?  Are you invested in individual stocks, bonds, mutual funds, ETFs or insurance products?  How does each fit into your tolerance for risk and into your overall investment picture?

There are statistical, well-understood reasons for diversifying a portfolio. But understand that diversifying with a broader mix of assets likely means you will always have some asset class or sector that underperforms the overall market, just as you likely will have some sections of your portfolio that do better.  You will always in your mind have too much of what’s underperforming and not enough of what’s hot.

Understand what you are paying for—fees, taxes and hidden costs. 

Rebalance the portfolio if necessary, especially if an asset class or sector becomes significantly out of line with your original portfolio allocations.  Take care to understand any tax consequences that might occur from doing this.   

Tax harvest.  In taxable accounts use strategies that pair off any losses you might have with any pre-existing gains.  Don’t compound a rotten year in stocks by paying Uncle Sam next April when you could have done something about that now. 

Note also you can follow us over at our blog:  Solas! { http://lumencapital.blogspot.com}

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

Schedule is a bit hectic next week so we'll commit to posting Monday, Tuesday and Thursday next week with break-ins if needed. 

Recent Investment Commentary {Part IV}

Here's part IV of the investment commentary we sent out last week.

With that being said, there are enormous advantages to ETFs, especially during volatile times.  We can invest during such periods knowing we are buying a diversified portfolio of assets, backed by the value of an underlying index while removing single stock risk.  The history of equities tells us they can be wracked by fraud, can trade to zero due to a catastrophic loss or be rendered obsolete by unforeseen technological change.  It is an extremely low probability event that a plain vanilla ETF, especially one with a long trading history and based on a well-established index, will suffer such a catastrophic event causing it to lose all value.  We say this is a low probability event because 30 years of investing tells us there are no guarantees.  However, the inherent value of the underlying assets and the unique creation and redemption process of ETFs make this unlikely. Because the underlying assets supporting ETFs have value, we can use our systematic approach to creating portfolios and strategies from this asset class.

Yield is also an underestimated portion of ETF returns.  If for example you buy an ETF based on the S&P 500*, such as the SPY, you are paying for an index that has historically grown its earnings in the 5-7% range, historically grown its dividend about 5% a year on average and currently pays nearly a 2% dividend.   If the market trades sideways in 2016 you would still have a security that pays you the same yield as current bonds but with a longer-term equity kicker.  That is the power of ETFs.

We'll post the conclusion to this letter tomorrow.  

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

Recent Investment Commentary {Part III}

I am posting in serial form this week a copy of a recent communication we sent out last week to friends of Lumen Capital Management, LLC.  Today is Part III.

However, the market is the ultimate arbiter of price.  It will meander as investor sentiment allows and it does not care what our analysis suggests. It is for this reason that we developed our playbook, which is a probabilistic assessment of what might occur, based on history.  This is also why we always have a game plan, which is the strategic positioning of investments and asset classes in client accounts based on the playbook’s assessment.  Currently the game plan is telling us that stocks are correcting more by time than by price and to watch how stocks respond to these various trading ranges.  An unexpected event likely would change our thinking, as would a market or economy that shows more deterioration than we’re currently seeing.  Absent that we would look for value in any subsequent decline and keep our current investment exposure.  

We built up cash in most accounts earlier in the year, as we couldn’t find much to buy at attractive valuations. So far {and depending on client mandates} we’ve viewed declines as an opportunity to add growth oriented Exchange Traded Funds {ETFs} at valuations where we see opportunity over the next 6-18 months and where we can find attractive yields.  We think interest rates will remain at historically low levels even if they rise slightly next year.  Important to our analysis is these ETFs also have the potential to increase their dividends over time.

 I also want to briefly discuss the attractiveness of ETFs as investments. In doing so, let me first say what they cannot do. ETFs will not keep your portfolio from losing value in bearish periods.  ETF’s track their underlying indices for good or ill.  They will trade higher or lower depending on their fundamentals and the underlying structure of the index they track.  ETFs can also be volatile.  This will be more obvious on days when market liquidity dries up.  However, increased volatility has more to do with how markets have evolved in the last decade than any underlying issue with the ETFs we follow. I will also repeat that we know of no mechanism or system short of being 100% in cash that can completely protect a portfolio from volatile markets.  If Warren Buffett has not developed a way to protect his portfolio from market declines then we surely are not about to.  While there are ways to hedge a portfolio, these can be expensive and will often produce losses as a function of the hedge that the average investor is not willing to tolerate.  The best hedge in our opinion for a portfolio is cash. 

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

Part IV will be posted tomorrow.

Recent Investment Commentary {Part II}

I am posting in serial form this week a copy of a recent communication we sent out last week to friends of Lumen Capital Management, LLC.  Today is Part II.

We use an evidentiary process that gives us an expected trading range for stocks. This “Cone of Probability” is our road map and is our current assessment of the market’s potential during a specific period.  We have mostly carried this year a range of 1750-2200 for the S&P 500*.  We’re not going to change these assumptions but we now think it is less likely that we’ll see 2,200 this year. Probability also suggests that the lower range of 1,750 will unlikely occur in 2015 unless some unlooked for event occurs.   We will update our 2016-17 targets in our next letter.

Markets have traditionally seen corrections of 10-20% so our recent decline was about average. Investors hate this kind of volatility but tolerate its fluctuations as the cost for longer-term superior returns.  The concern with corrections whether we are on the verge of something worse.  We think not based on current evidence and here’s why.  Typically corrections that turn into bear markets have weak growth plus something else.  There have been five bear markets where stocks went through multi-year periods losing near or in excess of 50%.  Each of these experienced the combination of a weak economy plus outside events.  1929-33 was the Great Depression.  The 1937-42 decline began when the Federal Reserve tightened monetary policy too early believing the worst of the Depression was over and then World War II came along.  1972-1974 saw the Vietnam War, oil price shocks and massive inflation from wars in the Middle East and political scandals culminating in President Nixon’s resignation.  2000-2003 started as a typical correction at the end of the Dotcom bubble but became something worse in the aftermath of the September 2001 terrorist attacks, as well as subsequent wars in Afghanistan and Iraq.  The 2007-09 declines rose from the worst financial crisis since the Depression. 

In my thirty years investing for clients stocks have also experienced declines of at least 20% from recessions {early 80s recession induced to break inflation}, Wars {Iraq 1990-1991}, natural disasters {Katrina 2005} and financial turmoil {Savings and Loan Crisis 1989-1990, Asian debt crisis and Long Term Capital Management, 1998}.  While facts might change, we are not currently seeing these kinds of events. What’s more stocks after each of these declines recovered and eventually resumed their advance.  That is because the US economy changes and adapts.  The reason we think stocks see limited downside is that the US economy is growing.  The 2^nd quarter’s annualized GDP at nearly 4% was an expansionary number not seen in years.  This came with many sectors of the economy, {energy, materials, and industrials} struggling with low prices and a high dollar.   Most statistics also support the assumption that our economy is growing.  Expansions support and sustain bull markets. 

Part III will be posted tomorrow.

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

PS.  After I sent this off I found this link over at Business Insider, "Six Signs We're Nowhere Near  A Recession".  It's data like this that suggests the weight of long term evidence still points towards expansion.  Note this link was not a part of our original communication.