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.