4th Quarter 2004 Review

From the Desk of Ron Rowland

One of the benefits of having your assets managed by CCAM is that your portfolio will generally have a relatively low correlation level to the stock market. In other words, our programs tend to move independently of the broad market averages. Most people consider this part of the attraction to CCAM, and it is definitely a benefit. However, there are times when it is difficult to understand why it is something we should want.

One of the advantages of having a low correlation level is that a portfolio is not vulnerable to the full risk of the market. Granted, there are still risks, and plenty of them, but a portfolio with low market correlation is typically less vulnerable to the full wrath of the market.

At CCAM, we use various benchmarks to help investors understand the short-term volatility that they can expect. For example, our more aggressive investment programs are benchmarked to the Nasdaq Composite Index. These portfolios can be quite volatile on a daily, weekly, monthly, quarterly, and annual basis. However, since they also have relatively low correlation to the market, we have been able to reduce other risk statistics (such as maximum drawdown) over a full market cycle. During the 2000-2002 bear market, our portfolios that were benchmarked to the Nasdaq Composite experienced losses that were less than half of what that particular benchmark did.

This type of result was not limited to just our portfolios benchmarked to the Nasdaq. Many of CCAM's portfolios benchmarked to other indexes achieved similar results. These portfolios tended to have losing periods that were only half as severe as those experienced by their benchmarks.

Of course, having low correlation to a benchmark is not the same as having no correlation. Ideally, what we would really like is to be 100% correlated to the market when it is going up, and 0% (or -100%) correlated when it is going down. This would certainly make life very pleasant for everyone. Unfortunately, it is not a likely to happen in the real world.

If we assume that a given portfolio is going to outperform its benchmark over a full market cycle, and we further assume that it is going have lower risk than its benchmark, then it is easy to fall victim to the false expectation that the portfolio will outperform its benchmark over any randomly selected period of time. That is not the case.

If you recall, having relatively low correlation means that your portfolio will not always be moving in sync with the market. The same phenomenon that allows your portfolio to often decline less when the market is falling may also be at work when the market is rising.

Recent history provides us with an excellent example. Many of the CCAM portfolios had returns that beat their benchmarks over the past six weeks, six months, and six years. In other words, they have beaten their benchmarks over the short-term, the intermediate-term, and the long-term.

However, as is often the case when portfolios do not move in tandem with the markets, these same comparisons may not hold true if we alter the time periods slightly. Over the past 12-week and one-year periods, many of these same portfolios lagged their benchmarks.

In 2004, some of our portfolios - typically those with the higher risk profiles - dramatically outperformed their benchmarks. Others lagged behind their benchmarks. Does this mean that the outperformers are superior, and the laggards are inferior? Absolutely not. It means that 2004 was a period in which risk-taking was rewarded. This is not always the case.

A single year, whether gain or loss, is not sufficient basis for drawing conclusions about a portfolios long-term potential. If 2004 was a winning year for you, it would be a mistake to assume that next year will be equally pleasant. The opposite is also true.

In the last ten years we have seen bull markets, bear markets, and everything in between. Our programs have, over time, successfully met their objectives. We have every reason to believe they will continue doing so. We do not yet know all the challenges and opportunities the coming year will bring. We do know that we will face them with the same focus and discipline that have brought our clients success over the years.

The Quarter in Review

The fourth quarter saved what was otherwise on track to be a sub-par year for the stock market. As of September 30th, the S&P 500 Index was up only 1.5% and the Nasdaq Composite was down by -5.3% for the year. A rally began in late October and accelerated in November through year-end.

Throughout 2004 there were numerous false starts and sharp reversals in various markets. Recognizing this, we were largely out of the market from May through October. In hindsight it is now clear that August 12th marked a low for the year, but of course we did not know it at the time. We came into the fourth quarter with a cautious stance in most of our programs, reflecting these difficult trading conditions and market angst regarding the impending elections. As the rally continued, our technical indicators strengthened and we increased our equity exposure throughout November and December.

November also brought an end to the strong uptrend in energy funds that had been beneficial to our sector programs. Crude oil reached a top above $60 then fell back to a trading range in the $40s. The broader uptrend in natural resources, including gold and basic materials, broke down and momentum shifted to technology and small-cap stocks.

As with every year, 2004 brought a number of surprises. Rising oil prices and short-term interest rates would normally be expected to hurt stocks and bonds, and there was some concern about this at various times. Yet, in the big picture, stocks generally managed to shrug off both concerns.

Looking forward to 2005, the "expert" forecasts are all over the board. We have found that our technical indicators are usually more dependable, and certainly more consistent, than the various market wizards we see in the media. We therefore don.'t have a forecast for what will happen in the next year. We will continue following our time-tested momentum strategy and stay with the trends, wherever and whenever they may be.

CCAM News

Deposits to Your Account - Please be advised the best way to obtain fast and efficient credit to your brokerage account is to make checks payable directly to the custodian. If you remit a check payable to CCAM, we are required to return the check to you and consequently, there is a delay in processing your deposit. Anytime you make a check payable to the custodian, you can either mail it directly to the custodian or mail it to us and we will deliver it to your custodian.

Preliminary Tax Reports - Preliminary tax reports have been sent for the 2004 tax year. If you have taxable accounts with CCAM and have not received a preliminary report, please call us at (800) 767-2595. In addition, we can send copies of these reports directly to your accountant. Please send us a letter or fax with your accountant's name, address, and phone number along with permission to send these reports on your behalf.

Reaching A Milestone - The end of December marks the 10th anniversary for several of our programs. Fidelity Single Sector, Fidelity Multi-Sector, No-Load All Star and Flexible Income now have a 10-year performance history. This is a significant milestone in our industry, as many investment programs do not survive so long. We continue striving toward even greater success and look forward to the next decade.