January 4th, 2009

Measure So You Can Manage: Where to From Here?

In my previous life as a financial executive, I firmly advocated a saying attributed to Dr. Edward Deming (the consultant who’s often credited with turning around the Japanese economy in the 1950’s and 60’s through a focus on quality): “You can’t manage what you don’t measure“. where measurement requires 1) knowing what to measure (total portfolio value including capital gains, losses, dividends, interest, less expenses), 2) having a metric (relative performance) and 3) a benchmark (the S&P 500 Index on a relative performance basis). I’m compulsive about this and post results daily in a spreadsheet (with graphs).

Last March, in “Market corrections are great; bear markets are even better” I wrote

“Those of us who’ve had big chunks of their portfolio in cash have preserved their capital and are well positioned to jump back into the market with more than both feet (on margin, that is) when the MTI signals that risk has been reduced. That’s going to be a while off, unfortunately, but it feels pretty good seeing your portfolio staying relatively in tact while most stocks are beginning to be offered at discount prices. Stay calm, stay cool, be patient. The time for stock selection will come but it’s not right now.”

So did the strategy pay off? Here are my results (granted, they’re unaudited so you’ll have to take my word for it):

Yes, I did suffer a loss but most of it came during the first three weeks of last year when my portfolio declined 5.40% as the S&P 500 declined 7.92%. But after I decided to embrace with confidence the MTI and moved into an all-cash position, my portfolio declined only 2.83% (my gold and silver hedges backfired starting in July) as the S&P 500 dove another 33.20% over the remainder of the year. On March 1, 2008, in “1973 and 2001 Market Crashes and Today’s S&P 500 Index“, probably one of the first such articles anywhere, I wrote:

“Of course, no one can predict the future and I’m not trying to do that here. What I am saying is that previous occurences of this crossover were precursors of further adverse momentum and market deterioration. Contrary to what the TV talking heads tell you, it’s no time to be buying on the dips! On the contrary, when the crossover does occur it’s time to buy puts on the market and load up on Ultrashort ETFs.”

I’m not happy about an 8.07% decline – but the consolation is that 67% came in the first 3 weeks of the year; it’s a very favorable performance relative to the 38.49% decline in the benchmark.

But that’s history; where are we headed from here? The stock market is like a huge voting machine. Those who believe the market will be headed higher vote as buyers and those who believe the market is headed lower vote as sellers. And every minute of ever trading day we can tally the vote count to see which way the voting is going.

Rather than digesting and analyzing reams of statistics ourselves, we chartists look at the on-going tally to see which way the majority of investors are voting. Like the public opinion pollsters (at least those who are independent, impartial and honest), we attempt to measure trends and forecast expectations based on statistics and previous patterns.

I read many stock market blogs to see how other bloggers are casting their votes as we start off the new year and what I see is a mixed and confusing investor public. Nearly half say we’re experiencing a temporary “Obama-bounce” and the honeymoon will soon end as reality about world economic and political conditions resurface. The other half point to a forthcoming economic stimulus package as the spark to firmly turn the market around. I love “stock picking” but that’s a waste of energy if the market is moving in the opposite direction.

I’m going to stick to the game plan. As I wrote to Peter, a dedicated reader of this blog who asked for my opinion of commodities,

“I own some X, AKS, DBA, OIL, GLD and SLV (these comprise the greatest percentage, 40%, of my longs). I also am looking to maybe put on some coal stock, either ACI, JRCC or YZC. I can’t predict how long or how far the run might be (whether it’s merely a bounce from an over-sold position or a return to a secular move up) but I’m edging in deeper as commodities continue to show strength. I’m a firm believer of the ‘revert-to-the-mean’ principal so while the commodity run-up to July, 2008, was too rapid the decline over the second half was way over done.

Having said that, I’m still 75% in cash. My plan is to marginally increase to 50% if the S&P continues its march up to the 180-day moving average. But we’re getting ahead of ourselves.”

More tomorrow on the “march to the the 180-day moving average”.

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