Paul Dietrich's Global Investing Trends Report

Managing Investments In A Volatile Market

Posted May 18, 2010 · 1 Comment

Dear Paul,

 

With the stock market in the U.S. dropping, the European Financial Crisis continuing, the Chinese stock market sinking and even oil and commodities going down, how does one manage investments in such a politically difficult and volatile environment?

 

The answer to your question is that you manage investments Very Carefully in these volatile markets!  The price of “impatience” is likely to be very high indeed! 

 

Today Risk Management Is Everything!

 

Benjamin Graham, the famous economist and Columbia University professor, once wrote, “The essence of investment management is the management of RISKS, not the management of RETURNS.”  He said, “Well-managed portfolios start with this precept.”

 

Since last November, I have been warning in these Foxhall Global Outlook newsletters that we were historically due for a significant U.S. stock market correction.

 

I believe over the next six months between now and the end of October we are going to struggle through a very difficult restructuring in both U.S. and global markets.

 

The U.S. Stock Market Is Out-of-Sync With The U.S. Economy

 

Look at the graph below:

  

     Source: S&P 500 Index Data Yahoo Finance.  GDP Data: U.S, Department of Commerce

 

The problem investors’ face right now is the U.S. stock market is completely out-of-sync with the underlying U.S. economy.

 

As you can see by the graph above, from the bottom of the last bear market on March 9, 2009, just a little over a year ago, the S&P 500 Index has outperformed and outpaced the underlying economy by over +61%.

 

That kind of substantial divergence from the underlying economy cannot continue forever!

 

The laws of statistics state that whenever two trends diverge they must always “regress to the mean” of their underlying fundamentals—which is the basic U.S. economy.

 

Over the past year, the U.S. stock market has shot up without a major correction.  We haven’t seen such a long and sharp upward movement in the stock market after a severe recession since the 1930’s and the correction that followed that post-recession bull-run was not pretty.

 

How Much Is The Stock Market Overvalued?

 

As I have mentioned before, some analysts believe a stock market correction, after the recent pull-back, of 10% to 15% more would be extremely beneficial and would bring the stock market and the economy back into some rough balance.

 

The stock market is now down 7% to 8% from the peak and it may slide further over the next few months.

 

Investors hate corrections or any stock market drop.  But in the long run it is far more healthy and stable to have a stock market that is running in tandem with the fundamentals of the U.S. economy.

 

Here is how the major global indexes have performed year-to-date:

  

                                      Graph Source: ETFreplay.com

 

As you can see from this graph, the S&P 500 Index (the broad U.S. stock market) has been the best performing stock market in the world for the past five months.

 

Most of the other major international stock markets have already experienced major corrections over the past six months.

 

Europe is down -11.1%, year-to-date as of May 18, 2010.  With the possible exception of the United Kingdom, the prospects for the rest of Europe look bleak over the next few years.  Growth will be mostly flat.  Analysts believe the Euro will continue to decline against the dollar and gold.  Inflation will eventually rear its “ugly head” as Europe degrades its currency to pay for the trillion Euro bailout of Greece, and probably, Portugal, Spain, Italy and Ireland.  Many financial experts also believe this will be just a “down payment” to buy time.  No one believes the weak political leaders of these debtor countries have the political will or power to force their parliaments to implement the difficult structural changes needed to comply with European debt to GDP requirements.

 

Foxhall Capital has had almost no exposure to European securities for several months.

 

Asian stock markets have also experienced major stock market corrections.  Since November, the broad Shanghai Composite Index is down over 22%.

 

As you can see by the chart below, the China Blue Chip Index, the FTSE China 25 Index is down over 9% year-to-date. 

 

Other Asian Countries have substantially outperformed China since the beginning of the year.

 

 

                                          Graph Source: ETFreplay.com

 

China has the enviable problem of trying to slow down the explosive growth in its economy—especially its property markets.

 

The Chinese Government has moved aggressively to slow down lending and investment in what looks like a “bubble” in residential and commercial real estate.

 

Most analysts think the government is doing everything mostly right.  Their problem is not nearly as bad as it was here in the United States or Europe.  First, all Chinese buyers must put down 20% on their primary residence and a 40% down-payment on any investment property.  Chinese investors are also limited to 3 investment properties.

 

They did not get 125% mortgages, like we gave away in the U.S.  It is also less likely they will “walk away” from a mortgage when they have invested 20% to 40% down-payments.

 

There is little to no chance of bank failures, since most mortgage lending banks are government owned.  So even if the government has to take over some mortgages, they have more than a trillion U.S. dollars in surplus reserves that could be used for those purchases.  China will not have to “print money” in order to bail out their banks.

 

Nonetheless, until it is clear that China has effectively slowed down its economy and drained liquidity out of the real estate lending market, there will probably not be a turn-around in the Chinese stock market until early this fall.

 

While we remain invested in Asia, because of the housing bubble in China, Foxhall has significantly reduced our current exposure to Chinese stock markets.

 

Other Asian stock markets, like India, Singapore, Malaysia, Indonesia, South Korea and Taiwan seemed to have bottomed out and are now starting to recover.  These may be the stock markets that will start to break out later this summer.

 

What About Gold?

 

Gold has hit new highs over the past few weeks as primarily Europeans have sold their Euros and bought both U.S. dollars and gold.

 

Gold can be a good investment, but because so many people purchase it out of fear over some imminent political or economic crisis, it can sometimes feel like riding a roller coaster in terms of price swings and volatility.

 

At Foxhall Capital, Hard Asset Commodities are always an important part of the risk management effort in the diversified strategies. This strategy can be a good investment in and of itself because of the global demand for commodities like oil, steel, gold and other “hard assets.”  In the diversified strategies, Hard Asset Commodities tend to perform better when stock markets are showing weakness.

 

But hard assets will become a really spectacular investment, and perhaps the Only Investment, in a few years that will maintain the “buying power” of your investment portfolio as we move into a period of hyper inflation after trillions of U.S. dollars and Euros are “printed by governments” for their bailouts, stimulus packages and deficit spending programs.

 

If you want to sleep well at night as an investor, the best way to invest in the global infrastructure investment trends and hedge your investment portfolio in the future against the loss of buying power caused by inflation, is to be invested in a very broad basket of commodities like oil, steel, basic materials, farm commodities, gold, silver and precious metals.

 

Foxhall’s ETF Series Global Hard Asset Strategy currently has a 20% allocation to silver.  (Note that the diversified strategies include an allocation of approximately 10% of their equity component to Global Hard Assets.  The holdings are always the same as in the ETF Series Global Hard Asset stand-alone strategy.)

 

While gold gets all the press, as you can see in this graph, Silver has outperformed Gold year-to-date as well as over the past year.

  

                                                      Graph Source: ETFreplay.com 

 

How Foxhall Protects Client’s Portfolios

 

As I mentioned before, in the long-term, the U.S. stock market reflects and tracks the underlying U.S. economy.  Analysts project that the U.S. economy will grow this year by only 2% to 3%.

 

And yet, over the past three weeks, the U.S. stock market has moved up or down by over 3% several times in a single day!

 

That is the very definition of volatility!  And during two days over the past three weeks we have seen the sixth highest volatility in the history of the U.S. stock market.

 

This volatility is the primary reason Foxhall Capital has maintained fairly significant positions in cash and U.S. treasury bonds in most of our client’s portfolios over the past six months.

 

This conservative risk management technique helped Foxhall portfolios to outperform over the past few weeks.

   

How Have Foxhall Accounts Performed Year-to-Date?

 

The month of May, 2010 is proving to be one of those times that “tests investor’s patience!” 

 

The S&P 500 Index gave up over 4% or roughly 2/3 of its 2010 gain in the first two weeks of this month. 

 

So how has Foxhall Capital’s investment strategies fared in May?

 

May 2010 (Month-to-Date to 05/14/2010) - Supplemental Information

  

Foxhall Global ETF Strategies

Net      Return

S&P 500  w/divs

Foxhall      Difference

Conservative

-2.66

-4.19

+1.53

Balanced

-3.07

-4.19

+1.12

Growth & Income

-3.51

-4.19

+0.68

Growth

-3.98

-4.19

+0.21

Pac Rim/Emerging Markets

-3.51

-4.19

+0.68

Global Hard Assets

-5.15

-4.19

-0.96

Strategic 50/50

-4.35

-4.19

-0.16

 

 Foxhall Capital Invests Globally

 

It is important to remember that only about 40% to 60% of Foxhall Capital’s investment portfolios are invested in the United States stock market.

 

The S&P 500 Index represents the 500 of largest U.S. based companies.  BUT, the S&P 500 Index is not a “proper benchmark” to measure Foxhall’s global strategies, although it is a reasonable point of reference for those of us that live in the U.S!

 

As you can see in the charts presented earlier, almost all global markets have significantly underperformed the U.S. stock markets year-to-date.

 

That trend may be reversing shortly, but for the past few months the S&P 500 Index has outperformed Asia and emerging markets, Europe, Japan and other foreign developed markets—and even hard asset commodities.

 

Long-term, almost every investment analyst agrees that China, India, Brazil and other Asian and emerging market countries will produce higher levels of growth than the U.S.

 

That is why the Foxhall growth strategy specifically maintains significant allocations to those countries and regions via the Foxhall Pacific Rim/Emerging Markets allocations and the Foxhall Global Hard Assets strategy allocations.

   

What Does Foxhall Do To Specifically Manage Risk?

 

I’ve always believed that the true measure of an investment manager is how high a priority they place on risk management and rigidly limiting client portfolio losses.

 

This is how our Foxhall Capital Preserve, Defend & Protect Risk Management Strategy works.  When volatility in the stock market goes up, Foxhall Capital automatically increases the amount of cash and U.S. government bonds in our client’s investment accounts.

 

This has really helped Foxhall clients to buffer the stock market turndown over the past few weeks.

 

With the exception of the Pacific Rim/Emerging Markets Strategy, the table below shows Foxhall outperforming year-to-date the Global Blended Index Benchmarks for each strategy. 

 

Year-to-Date to 05/14/2010 — Supplemental Information

 

Foxhall Global ETF Strategies

Net Return %

S&P w/ div

Global Blended  Index Benchmark

Global Index Benchmark Outperformance

Growth

-0.93

+2.56

-2.26

+1.33

Pacific Rim/Emerging Markets

-6.32

+2.56

-4.54

-1.79

Global Hard Asset

-0.94

+2.56

-5.60

+4.66

Strategic 50/50

-3.68

+2.56

-5.07

+1.38

 

 

 

 

 

401k-Develop Markets

+3.03

+2.56

-0.51

+3.54

 

 Investment Returns MUST Be Viewed Over A Minimum 3-to-5 Year Period

 

We always talk about Foxhall’s risk management process, but I think the chart below tells the entire story in one picture of our Foxhall performance over the past bear market from the peak of the last bull market on October 9, 2007 to March 31, 2010.

 

During that modern-day “Great Recession” until the end of last quarter, the Foxhall ETF Global Growth Strategy outperformed the S&P 500 Index by 16.8% and with 82% less risk (0.18 BETA).

 

That Is One Of The Best Investment Performance Records In The United States For The Last 2 ½ Years!

 

 

The Lost Decade:  NOT AT FOXHALL CAPITAL !

 

Financial magazines and cable news shows now call the decade from January 1, 2000 to December 31, 2009, the Lost Decade.  That is because during that Lost Decade, the S&P 500 Index lost money and was negative for that 10-year period.

 

However, at Foxhall Capital, and because of our conservative active risk management investment strategies, our Foxhall ETF Global Growth Strategy outperformed the S&P 500 Index by over 80% during that 10-year period and, again, we did it with 80% less risk (0.19 BETA), as you can see in the graph below.

 

 

 

Where Do We Go From Here?

 

Over the next few months through October, I believe we may see continued turmoil and real volatility in the stock market as both the stock market and economy try to find some equilibrium. 

 

Again, over the long-term this is a healthy process.  But in the short-term, this turmoil and transition may be unpleasant.

 

We must always remember and keep in perspective that this is a pull-back and correction within a long-term bull market. 

 

The definition of a long-term bull market is everything is broadly going up over a five to eight year period.  That is why investors don’t want to completely exit the stock market unless all our Foxhall “stop-loss targets” are triggered.

 

Until a “stop-loss target” is triggered, Foxhall will primarily manage risk in our client’s portfolios by increasing cash and U.S. treasury bonds while volatility in the market remains high.

 

I strongly believe that once we go through the summer and early fall; I can see a sustainable bull market sometime after October.  Will the ‘roller coaster ride’ smooth out and become more like a ‘walk in the park’?  Not very likely!  However it plays out, Foxhall’s disciplined approach to managing investment risk and portfolio volatility is firmly in place and providing thoughtful investors with effective global investment exposure.

 

 Until then!

 

—Paul Dietrich

dietrich@foxhallcapital.com

800-416-2053

  

Disclosures: The opinions and portfolio information provided in the Foxhall Global Outlook are subject to change at any time, and are not to be construed as advice for any individual nor as an offer or solicitation of an offer for purchase or sale of any security. Client accounts may differ from model allocations due to many reasons. All investment strategies offer the potential for loss as well as gain. Individuals should consult with their financial professional to determine an investment strategy appropriate for their objectives, risk level, and time horizon prior to investing.  Past performance is not a guarantee of future performance.

 

 Foxhall Capital Management, Inc. is a registered investment advisor with the US Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. The “firm” is defined as the Foxhall Capital Global ETF, 401(k) and Stock Series divisions which manage a variety of ETF, 401(k) and Stock strategies in bundled fee and non-bundled fee accounts for primarily US clients. The firm was redefined as of 12/1/08 due to the creation of the 401(k) Series division. The “entity” is defined as the Foxhall Capital Global ETF Series, the 401(k) Series, the Global Stock Series and the Variable Insurance Series.  Valuations and returns are computed and stated in U.S. dollars. Net of fees returns are calculated net of management fees and transaction costs are gross of custodian fees.

 

The GLOBAL CONSERVATIVE STRATEGY (creation date 2/12/2004) has a target equity allocation of 25%.  The GLOBAL BALANCED STRATEGY (creation date 5/5/2004) has a target equity allocation of 50%.  The GROWTH & INCOME STRATEGY (creation date 3/22/2004) has a target equity allocation of 75%.  The GROWTH STRATEGY (creation date 12/31/1999) has a target equity allocation of 100%.  The PACIFIC RIM AND GLOBAL EMERGING MARKETS STRATEGY (creation date 11/11/2005) uses a ranking system to select a CONCENTRATED portfolio of highly ranked Asian and Emerging Markets funds, in terms of relative strength.  This strategy has a target equity allocation of 100%.  The GLOBAL HARD ASSET STRATEGY (creation date 08/17/2006) uses a ranking system to select a GLOBAL portfolio CONCENTRATED in high relative strength funds that tend to profit from either RISING OR FALLING GLOBAL HARD ASSETS OR CURRENCIES, or both. This strategy has a target equity allocation of 100%.  The STRATEGIC 50/50 STRATEGY (creation date 09/30/07) has a target allocation concentrated in 50% Asian and emerging market equity funds and 50% in global hard asset funds.  This strategy uses a ranking system to select a CONCENTRATED portfolio of highly ranked Asian and Emerging Market funds, in terms of relative strength and funds that tend to profit from either rising or falling global hard assets or currencies, or both. 

 

All of the strategies may move entirely to non-equity funds as a defensive position during major market declines or economic recession. Prior to May 1, 2006 each of the sub-advised managed accounts are counted as individual accounts and as of May 1, 2006 and later they are treated as one aggregate account.

   

 

 

 

* Partial Period Return.  (1) S&P 500 Index w/divs  (2) 75%-1, 25%-Barclays Capital Intermediate U.S. Government/Credit Index (formerly Lehman Brothers Intermediate U.S Government Credit/Bond  Index) (3) 50%-1, 50%-Barclays Capital Intermediate U.S. Government/Credit Index  (4) 25%-1, 75%-Barclays Capital Intermediate U.S. Government/Credit Index  (5) 40% Russell 3000 Total Return Index, 30% MSCI EAFE, 20% MSCI  Emerging Markets, 5% CRBI Reuters Continuous Commodity Index, and 5% Rogers-VanEck Global Hard Asset Producers Composite Index (6) 25% Barclays Capital Intermediate U.S. Government/Credit Index, 30% Russell 3000 Total Return Index, 22% MSCI EAFE, 15% MSCI Emerging Markets, 4% CRBI Reuters Continuous Commodity Index, and 4% Rogers-VanEck Global Hard Asset Producers Composite Index (7) 50% Barclays Capital Intermediate U.S. Government/Credit Index, 20% Russell 3000 Total Return Index, 15% MSCI EAFE, 10% MSCI Emerging Markets, 3% CRBI Reuters Continuous Commodity Index, and 2% Rogers-VanEck Global Hard Asset Producers Composite Index (8) 75% Barclays Capital Intermediate U.S. Government/Credit Index, 10% Russell 3000 Total Return Index, 8% MSCI EAFE, 5% MSCI Emerging Markets, 1% CRBI Reuters Continuous Commodity Index, and 1% Rogers-VanEck Global Hard Asset Producers Composite Index (9) 50% CRBI Reuters Continuous Commodity Index and 50% Rogers-VanEck Global Hard Asset Producers Composite Index (10) 33% MSCI Emerging Markets, 17% MSCI EAFE, 25% CRBI Reuters Continuous Commodity Index, and 25% Rogers-VanEck Global Hard Asset Producers Composite Index (11) 67% MSCI Emerging Markets, 33% MSCI EAFE Index.

 

The 401k Developed Markets Composite (inception date 12/01/08) is primarily invested in exchange traded funds in the developed markets segments. This composite has a target equity allocation of 100%, however, the portfolio may move entirely to non-equity funds as a defensive position during major market declines or economic recession.  The 401K Developed Markets Performance:  YTD (as of 4/30/10): 401k: 3.29%; Benchmark+: 5.14%; 2009: 401k: 2.41%; Benchmark+:  28.59%; 2008: 401k: -0.15%; Benchmark+: 3.23%. +The Global Blended benchmark is based on a weighted average of 67% Russell 3000 and 33% MSCI EAFE Index and may be realigned monthly.

 

As with any investment strategy, there is potential for profit as well as the possibility of loss. Foxhall Capital Management, Inc claims compliance with the Global Investment Performance Standards (GIPS®). Foxhall Capital Management has been verified for the periods 12/31/99 – 12/31/08 by Beacon Verification Services. A complete list and description of all firm composites is available upon request.  PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


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very good post, i was really searching for this topic as i wanted this topic to understand completely and it is also very rare in internet that is why it was very difficult to understand. thank you for sharing this.

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About Paul Dietrich
Paul Dietrich is the Chairman, CEO and Co-Chief Investment Officer of Foxhall Capital Management, Inc. (Foxhall).  Foxhall currently manages investments for individuals, mutual funds and private institutions throughout the United States. Paul Dietrich is also a portfolio manager to a publicly traded mutual fund, the Foxhall Global Trends Fund.
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