2nd Quarter 2009 Review

From the Desk of Ron Rowland

Recently I read an interesting statistic from Morningstar, the mutual fund research firm. From January 1999 through December 2008, U.S. and global mutual funds focused on real estate appreciated by an average of +90%. At the same time, however, investors in those funds lost a total of about $5 billion.

How is it possible to lose money in funds that go up? The +90% return only applies if you bought at the beginning of the period and held for the entire ten years. This is not what most investors do. Often times, people buy mutual funds after the funds have already gone up and then sell them near a bottom. The result is a loss even when the overall trend is positive.

Why do people make this mistake? I can only speculate, but I think it is because they don’t have a time-tested strategy. Instead they react to all kinds of extraneous data points: news bulletins, fund advertisements, media stories, conversations with friends and relatives, and so on. Relatively few people get professional advice, and those who do are often too quick to ignore that advice and/or jump from advisor to advisor looking for better short-term results.

Of course, the last year or so demonstrated vividly that even professionals with proven strategies are not bulletproof when the economy crashes. We have had our share of challenges at CCAM. Nonetheless, we have not lost our discipline. Our primary method is to identify intermediate-term momentum and then follow it until the momentum moves elsewhere. We implement this with exchange-traded funds and mutual funds in our various programs.

Some might say "The markets are different now." Yes, the markets are different now. They are always different. If stocks simply did the same thing over and over again, all those investors in real estate funds wouldn’t have lost so much money. A changing investment environment is nothing new. CCAM has been dealing with change since it opened in 1994.

Personally, I find this encouraging. Why? Because change also brings opportunity. As the economy adapts to the structural changes of the last year, disciplined professional investors will have many chances to capitalize on new trends. I, for one, am looking forward to the many opportunities I think are coming our way. Thank you for your continued support.

The Quarter in Review

At the halfway mark, 2009 is still proving to be a wild year in the stock market. Quarterly numbers do not reveal the full extent of the volatility. In fact, it is probably more instructive to divide the first six months into three two-month periods. Broadly speaking, January and February were very bad, March and April were very good, and May and June were nearly flat

Since this is a quarterly report, however, we will review the calendar quarter. The S&P 500 posted a total return of 15.9%, the Nasdaq Composite rose 20.1%, and the Russell 2000 was up 20.7%. On a year-to-date basis the Nasdaq is well ahead of the other benchmarks thanks to its heavy weighting in technology and lack of financial sector exposure.

As usual, we will highlight sector trends by reviewing the SPDR Sector ETFs. These funds break down the S&P 500 stocks into nine broad sectors.

As you can see, Financials were the clear winner for the quarter, with the next-best sector more than 16 percentage points behind. XLF still showed a one-year loss of -38.7% even after this blowout quarter, vividly demonstrating the magnitude of losses the prior three quarters. The Industrial sector, as defined in the SPDR funds, is dominated by General Electric (GE) which also has a huge financial services business, and not surprisingly came in second place.

The lowest returns for the quarter - which may have been quite impressive under other circumstances - were the traditionally defensive Health Care, Consumer Staples, and Utilities sectors. In this comes the real story of the quarter: economic recovery expectations.

The bear market in housing that began in 2007 sparked a banking crisis in late 2008 which within weeks had spiraled into a near-panic. In due course, the doomsday fears receded somewhat but what remained was still a severe global recession, massive government deficits, rising unemployment, and falling consumer spending. Because it is mathematically impossible for markets to decline at annualized rates of more than -100% for a sustained period, a major upside correction was inevitable - and it happened, primarily in March and April.

It is entirely possible for the stock market to recover while the economy still lags, or vice versa. The bigger picture reveals a market held captive in a broad trading range, but there are still opportunities to capture outperformance. The Technology sector shows particular potential, as do selected overseas markets.

At the same time, we think it is prudent to remain cautious with an above-average cash position while the broad market is on such shaky ground. We are implementing this strategy in all our programs and will remain focused on the goal of posting solid returns with reasonable risks.