Letter to Investors: August, 2011 Results

For the 5 week period from July 29, 2011 to September 2, 2011, the SP500 lost 9.09%.  This was on top of the 3.48% loss suffered by the SP500 in the  prior reporting period (July 1 to July 29).  From January 1 through September 2, 2011, the SP500 is down 6.65%.

The biggest development over the past 5 weeks was price action that would be consistent with a bear market.  (I made the “call” on August 9.)There are lots of macro headwinds including but not limited to: 1) high and structural unemployment; 2) a moribund housing market; 3) poor political leadership; 4) debt; 5) European sovereign debt; 6) ineffective or lack of monetary policy options; 7) slowing global economies.  (I am sure I missed a few things.)  There is a real risk of recession if it isn’t here already.  When we put it all together, it shouldn’t surprise anyone that we are in a bear market.

To start the month, we had positions in the equity markets, but those trades were stopped out as the market fell out of bed.  As expected, sentiment towards equities turned ugly, and two short weeks later, we were back in buying at what has turned out to be the recent near term low.  At present these trades are profitable.  It has been my expectation that the current trade is a counter trend trade within an ongoing bear market.

The question becomes: what’s next?  It is difficult to see what the catalyst might be that could propel prices higher.  Investors have placed a lot of hope in the Federal Reserve, yet it isn’t clear if the FOMC is going to take action or whatever action they do take will soothe the markets.  One thing is for sure, there are fewer and fewer policy initiatives, and they are working with less and less effectiveness.  As usual, we won’t let the noise of the market guide our investing decisions.  At best I can see the market getting to the 200 day moving average.  On the downside, we won’t be afraid to cut our losses if the price action warrants.  It is very important to defend our capital here as breaks of support (while investor sentiment is bearish) can lead to waterfall declines.

As I stated last month: “Can the Fed save the day again?  There is always hope.  Hope isn’t a particularly great strategy, but in the absence of anything else, this is how most investors function.  While I always hope for the best, I follow our models to maximize returns.  The models don’t always get it right, but it is a much more efficient way to function in the markets.”

In Treasury bonds, our model remains positive.  The model has been positive since March, 2011.  Bonds have benefited from a weak economy and the fact that the Fed is  targeting asset purchases in the long end of the yield curve (i.e., Operation Twist).  All good things will come to an end, but bonds have been a great diversifier, and they remain highly uncorrelated to other asset classes.

In this past reporting period, gold was up about 15%, and this was on top of a 10% gain in the previous month.  Yikes!  Once again, huge returns.  But the fundamentals are supportive.  Falling interest rates and the expectation that the only policy response to all our ills will be more money printing are the drivers for gold.

The crude oil model gave a sell signal at the end of the last reporting period.  Over the month, crude dropped nearly 20% before recovering.  I like roller coasters, but not that one.  Fortunately, we did not have positions in crude oil.

For the 5 week period from July 29, 2011 to September 2, 2011, the Conservative Portfolio gained 2.23%.  Over the same time period, the SP500 lost (9.09%).  Gains were driven by positions in GLD and BND.  The XLU has been a relative out performer only when compared to equities (i.e., SPY).  We end the reporting period with positions in: SPY, GLD, BND, and XLU.

Since January 1, 2011, the Conservative Portfolio has returned 8.49%. Buy and hold S&P500 has returned -6.65%.  Results are through September 2, 2011.  The 2011 Conservative Portfolio equity curve v. buy and hold SP500 is shown in the next figure.

Conservative Portfolio v. Buy and Hold SP500/ 2011 return

The goal of the Conservative Portfolio is to generate a return equivalent to the long term returns (8.78% annualized total return since 1871) of the SP500.  Capital preservation is a hallmark of this strategy.

For the 5 week period from July 29, 2011 to September 2, 2011, the Broad Market Portfolio lost (7.99%).  Over the same time period, the SP500 lost (9.09%).  The Broad Market Portfolio is performing as expected — in line with the SP500 but with better gains and lesser losses.  When the market tanked earlier in the month, the  Broad Market Portfolio liquidated almost all of its positions.  Upon recovery, only a few positions were initiated as the majority of sectors “looked” poor from a technical standpoint.  The portfolio’s performance benefited from a position in bonds, which is taken as a hedge when the number of investable sectors drops below 5.  Current positions include:  XLE, XLU, IYR, BND.

Since January 1, 2011, the Broad Market Portfolio has returned a negative (3.05%). Buy and hold S&P500 has returned  a negative (6.65%).  Results are through September 2, 2011.  The 2011 Broad Market Portfolio equity curve v. buy and hold SP500 is shown in the next figure.

Broad Market Portfolio v. Buy and Hold SP500/ 2011 return 

The goal of the Broad Market Portfolio is to generate a return that exceeds the long term returns (8.78% annualized total return since 1871) of the SP500 with significantly less risk than buy and hold S&P500.

For the 5 week period from July 29, 2011 to September 2, 2011, the Aggressive Portfolio gained 4.61%.  Over the same time period, the SP500 lost (9.09%).  The portfolio benefited from higher allocations than normal to GLD and BND.  Earlier in the month, the equity positions were mild losers, but positions were reestablished at lower prices, and these are currently profitable.  Current positions include: GLD, BND, SPY, and QQQ.

Since January 1, 2011, the Aggressive Portfolio has returned 15.34%. Buy and hold S&P500 has returned a negative (6.65%).  Results are through September 2, 2011.  The 2011 Aggressive Portfolio equity curve v. buy and hold SP500 is shown in the next figure.

Aggressive Portfolio v. Buy and Hold SP500/ 2011 return

The goal of the Aggressive Portfolio is to generate a return that exceeds the long term returns (8.78% annualized total return since 1871) of the SP500 by 2-3 times.

Historical returns and portfolio examples shown on this website are not presented net of investment advisory fees or other transaction costs.  Actual performance results will vary from these examples.  Past performance is not indicative of future results. This material should not be considered a recommendation to purchase or sell any particular security or an offer to sell any product.  ARL Advisers, LLC reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

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