4th Quarter 2008 Review

From the Desk of Ron Rowland

I am sure it will not surprise anyone when I say that 2008 was a difficult year for investors. Nor is it news that the 4th Quarter of last year brought the worst market conditions many investors have ever seen. The global economy has entered unprecedented territory.

How did CCAM perform in this challenging (to say the least) environment? Most of our managed accounts delivered results generally much better than their benchmark risk profiles. Conservative programs succeeded in preserving capital while most aggressive programs fell much less than the markets they trade. In a year like 2008, this should be considered a victory, but I understand the frustration associated with negative returns.

Inexperienced investors often confuse absolute returns with relative returns. Absolute returns are supposed to be steady, like a bond that pays 5% annual interest. Relative returns vary based on the results of a benchmark like the S&P 500. For example, if the stock market goes up +10% and you make +15%, you have a +5% relative return. The market gave you +10% and your manager's skill gave you another +5%. Everyone should be happy.

When the numbers turn negative, however, this math stops making sense to many people. If the market is down -20% and you are down -15%, your account still beat the market by 5%. Your manager added value by keeping your loss smaller than it could have been. To many investors, that's not good enough. They want to beat the market when it goes up and have break-even or positive returns when the market goes down.

Any professional will tell you that such expectations are highly unrealistic. If you want equity-like returns, you have to accept equity-like risk. The reason Bernie Madoff's scheme was so successful is that he appeared to have solved this problem by delivering returns of around +10% every single year for decades. We now know it was all in his own imagination.

Now it may be that you are not willing to take equity risk in the current environment and are willing to accept lower long-term returns. I completely understand. In that case you may want to consider an income-oriented alternative like our Flexible Income program. The right answer depends on your own personal goals and situation. We’re here to help you work through those issues, so please let us know if you have questions. Rest assured that we are doing all we can to improve results in 2009. Thank you for your continued confidence.

The Quarter in Review

The last three months of 2008 are not easily summarized. Entire books will be written about this quarter’s events, their causes and consequences. Here is what we said in our last quarterly report

(10/20/2008) In the 4th quarter, markets will be preoccupied by the success or failure of government efforts to rescue the financial sector from its own folly and by the rapidly growing threat of a severe recession. Stocks seem likely to remain in a bear market for the foreseeable future, but there may still be opportunities to find growth in defensive sectors. We are working hard to find such opportunities.

Indeed, the fourth quarter brought more turmoil as the global economy hit a giant brick wall. Consumer spending plummeted, unemployment soared, world trade all but disappeared, and asset prices continued to sink. In the middle of all this the presidential election introduced a new element of uncertainty. Authorities spent staggering amounts of money propping up banks, brokers, auto makers, and assorted other industries. No one knew if it would be enough.

In the midst of this maelstrom, investors lost all appetite for risk. The result: a giant shift away from equities and toward bonds, specifically Treasury bonds. Interest rates plunged toward zero, and even briefly below zero for short-term Treasury bills.

In more "normal" market downturns, one or more sectors tend to move up or at least hold steady. For instance, during the 2000-2002 technology crash, financial stocks actually performed quite well. This time, there was nowhere to hide. Here are the 4th quarter and yearly results for the nine S&P Sector SPDR ETFs (including dividends):

As you can see, even the so-called "defensive" sectors like Utilities and Health Care had a rough year - much of which happened in the last quarter. When every sector is going down together, even rotational strategies like ours find profit opportunities elusive.

The New Year opened with even more losses. As of this writing, the benchmarks are down and everyone is waiting to see if President Obama can pull a rabbit out of his hat. We find it hard to be optimistic about the economy, but we are watching carefully for trends in niche sectors and international markets that may give us a chance for profit. Otherwise we are keeping all our strategies in a defensive posture until market conditions improve.