Part 1 - Observations on Market Gyrations - 3 / 25 / 2009

Lately, the horror stories concerning decimated 401k's and lost retirement accounts has brought to bear a significant misconception in any kind of investing, and most obviously equities investing. We, and I include myself in this, have been fooled by fund managers, traders, research analysts, the lot for 50 years now.

I recognize this is a statement that offers one response, "No Kidding". But I think it's the reason why we have been misled that offers some of the best examples of how to minimize its impact on your future and your children's futures. I have borne witness to much of what I will explain here for all of my professional career. And it's the investors, institutional and individual, that intuitively understand this and importantly ACT on this information who manage to protect their principal, protect their gains, and compound those gains over a 5 year, 15 year, and 20 year period of time.

So with that statement, we embark on a series of daily called "Observations on Market Gyrations" designed over time to enhance your capital market's perspective and ultimately your expertise. Each posting under this heading will highlight common investment issues and basic solutions to them and the perspective that took us from them.

First and foremost, the concept of professional fund management is, and always will be a farce at one level or another. Fund managers and fund companies exist to offer vast diversification and educated stock selections to individuals who want the opportunity to invest in equities but do not have the time or do not want to make the effort to review and select their own investments. But this said, it is the exception, not the rule that Fund managers perform better over a 5 year period than any of the major indexes. The reason for this is they seek out, as core portfolio holdings, companies with consistent earnings and proven management that come with good Moody's, Valueline, and S&P ratings and receive ample "Buy" recommendations from research analysts at the larger investment banks. Seems like a safe and consistent bet that, importantly, no investor in their fund can argue with.

A quick review of the core holdings from my random sampling of popular Growth and Income funds from major Fund Managers reveals the following corporation's stocks in their portfolios: Exxon, Procter & Gamble, General Electric, AT & T, Johnson & Johnson, Chevron, Microsoft, Wal-Mart, Pfizer, JP Morgan Chase. Big names, great companies. But here is a key problem. The entire research world spends hundreds of thousands of hours quarterly on these very same companies. The result is that each of the shares of these companies are fully valued and fairly valued by any metric that the equities research world bases their recommendations on. And fairly valued or fully valued shares UNDER PERFORM MARKET INDEXES. (P.S. We am not forgetting the dividend factor. But people, these companies pay very poor dividends which, upon announcement, reduce the price per share equivalent by the dividend amount. Its a zero sum to the holder. In our opinion, dividends that are not equal to 33% of the companies earnings are not dividends at all.)

If you invest in one of these companies or "hold" your position in one of these companies you are in fact speculating that the global industry these companies address will grow. That the economic environment that each of these companies operate in will continue to grow. And we all know now that speculation leaves you and your investment wide open for a market corrections and loss. Or does it?

There are simple preventative measures that all of us, fund managers included, can use to protect large losses. We will review these periodically, but the easiest one to remember is called a stop-loss order. In this type of order the investor in say Microsoft can enter an order to sell all or part of a position at a pre-set price that is below the current price of the stock. Thus should a interim correction occur, that ultimately becomes a bear market free fall, you as an investor have pre-set your gains or at least your selling price and therefor are protected from significant future loss.

Now People, we do not want to hear, "yes, but if my position is sold and the market for that position rallies, an hour later I could lose my upside". Because if that is your perspective you are a speculator, not an investor, and that means you are willing to risk your principal investment and perhaps your savings in order to have a chance to participate in a speculative market rally.

This brings us back to "professional" fund management. How is it that managers entrusted with your investments would rather speculate with your money than build its value incrementally? How is it that any of them shows a loss of more than 20% last year? Unfortunately its not for lack of ability of lack of training. It is complete lack of perspective. And hopefully, through this daily piece, we are building real perspective and therefore real value incrementally and over time.

Build Value Every Day.

Brad van Siclen