Paul Dietrich's Global Investing Trends Report

Why Foxhall Capital's Risk Management Strategies Are So Important!

Posted July 2, 2010 · 3 Comments

This is a Second Quarter-End Follow-Up to my last Global Outlook a few days ago on the current stock market correction and retrenchment.

 

As we end the second quarter of this year, the stock market is still in the process of regressing to the long-term trend of the underlying economy.

 

Based on how overvalued the stock market was before this correction, I believe the stock market may continue to correct for the next few months.

 

This Is Why Foxhall Capital’s Risk Management Strategies Are So Important!

 

Foxhall has been able to outperform the Dow and the S&P 500 Index since they began to correct in April.  Currently, Foxhall has moved significant percentages of our client’s portfolios into short-term U.S. Treasury bonds and money market funds to help protect them during this correction. 

 

Right now, our Foxhall ETF Global Growth Strategy is more than 23% in cash and treasury bonds; the Foxhall Pacific Rim & Emerging Markets Strategy is over 65% in cash and treasury bonds; and the Foxhall Hard Asset Strategy is over 26% in cash and treasury bonds.

 

I will talk more about how Foxhall Capital manages risks in this stock market correction a little later.

 

But FIRST, How Much More Could the Stock Market Fall?

 

As I have stated over the past few months, the problem has been that the U.S. stock market went almost straight up from March of 2009 until April of this year, while the underlying U.S. economy was roughly flat, just growing about 3%.

 

In short, the U.S. stock market was completely out-of-sync with the underlying U.S. economy.

 

Here is where the S&P 500 Index closed on Thursday, July 1, 2010.  I am reprinting this chart with the permission of Doug Short at dshort.com. 

 

 

This chart starts in October 2007 when the last bull market peaked.  The S&P 500 Index as of July 1, 2010 is now down -15.6% below its April 2010 high.  The chart also shows that the stock market would have to go up +34.4% in order to reach the breakeven point of the last bull market high reached on October 9, 2007.

 

So, Again, How Far Does The Stock Market Have To Drop To Be “In Sync” With The Underlying Economy?

 

Yale University Professor Robert Shiller has created a method of determining whether the U.S. stock market is over- or under-valued by using long-term 10-year Price Earnings ratios.  It has a great past record of market predictions.  After the recent drop in the stock market over the past 10 days, the current reading, as of July 1, 2010, of his Shiller P/E Ratio Valuation is that the U.S. stock market is currently still over-valued by about 10%.

 

Here is another chart I am reprinting with the permission of Doug Short at dshort.com.

 

 

Once again, you can see the long-term pattern of what the S&P 500 Index needs to do to get back into sync with the underlying U.S. economy.

 

If you watch all the profession financial television commentators, they are all wringing their hands and worrying that we are facing a new recession or that the world is coming to an end.

 

Nothing can be further from the truth.  The stock market is simply regressing to its long term trend and is once again coming into “harmony” with the underlying U.S. economy.

 

There is nothing wrong with this!  I have been publicly wondering for the past six months on the pages of this newsletter why it didn’t happen sooner.

 

How Does Foxhall Capital Manage Portfolio Risk In These Difficult Times?

 

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—as it is now.

 

The good news is I continue to believe that once we go through the summer and early fall; we will see a sustainable bull market sometime after October.  But however it plays out, Foxhall’s disciplined approach to managing investment risk and portfolio volatility is firmly in place.

 

At Foxhall Capital Risk Management Is Very Important

 

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.

 

As active investment managers, our primary function at Foxhall Capital is to manage the down-side risk of our client’s portfolios.

 

Warren Buffett’s mentor and Columbia University professor, Benjamin Graham 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.”

 

At Foxhall Capital, our primary objective is first and foremost risk management.  That means that our primary objective is to try to make sure that none of our clients experience significant loss of principal in their investment accounts.  Our next, but secondary objective is to increase the value of our client’s accounts.  But Risk Management is ALWAYS our

primary objective.

 

What Does Foxhall Do To Specifically Manage Risk?

 

This Foxhall Capital Preserve, Defend & Protect Risk Management Strategy also provides another level of risk management in bull markets.  When volatility in the stock market goes up like it is doing right now, Foxhall Capital automatically increases the amount of cash and U.S. government bonds in our client’s investment accounts.

 

As I mentioned earlier in this newsletter the various “Foxhall Core Investment Strategies” are currently over 23% to over 65% in cash money market funds and short term U.S. Treasury bond funds.

 

This has helped Foxhall clients buffer the stock market turndown over the past two months.

 

Secondly, we maintain a stop-loss on the overall client portfolio.  If a portfolio stop-loss is triggered, we will move the entire portfolio to cash or U.S. treasury bonds.

 

Thirdly, we maintain a stop-loss on all of the key indexes we follow.  That means if the stop-loss on the S&P 500 Index for the U.S., the EAFE Index for other developed markets, the Emerging Markets Index or the commodities index is triggered on one or more of these indexes, Foxhall will sell out of those specific positions.

 

Our theory is that whichever of these stop-loss targets hit first, we will start reducing our client’s exposure to the market.

 

Lastly, we monitor U.S. and global markets every day.  We have significantly reduced our exposure to Europe and some Asian stock markets.

 

Where Do We Go From Here?

 

Whether we like it or not the global markets are now all interconnected.  That means when there is a debt crisis in Europe or a housing bubble in Asia—it will negatively affect the U.S. stock market.

 

Here is the bottom line!  Foxhall Capital will use all of its Preserve, Defend & Protect Risk Management Strategies to limit our client’s portfolios to any significant loss.

 

We also must remember that this is a 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-losses 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.

 

As I have said before, even though this correction may play out over the next few months, and may feel unpleasant, this is something fundamentally very healthy. 

 

The stock market and the economy MUST return to some balance and I don’t know how that can happen without a correction like we are going through right now.

 

But once we go through this period, I can see a really sustainable bull market this fall.  I believe that all of the “sky is falling” predictions of a new depression from TV and Internet “investment gurus” are nonsense. 

 

All the stock market is trying to do is return to some semblance of balance with the underlying U.S. economy after a crazy and unsustainable upward trajectory since March 2009.

 

This is not more complicated than that!

 

 

 Until then!

 —Paul Dietrich

dietrich@foxhallcapital.com

800-416-2053

 

Disclosure: 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.

 

 

 


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Comments

Interesting! Since I am a client and I am, presumably, the first to read and comment on your blog. Do you mind emailing me the names of the studies completed in the 1960s and 1980s?
Posted by Stewart | November 28, 2010 8:13pm
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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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