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What I’ll be watching for during earnings season

Posted by Abigail M. Huffman, CFA on July 14, 2013 at 6:43 pm

This week corporations began reporting their quarterly earnings (half year for most of them.)  Many analysts expect large corporate revenues to be flat and for profits to be lackluster.  This differs from previous years where cost cutting has yielded exceptional profits despite mediocre revenues and cost cutting may have run its course.  While analyst mood is cautious, we may be witnessing groupthink.  From my perspective, analysts tend to have an early conservative bias so that any upside earnings reports make them look like heroes to happy clients.  Negative reporting surprises, such as lower earnings than expected, make everyone unhappy.  So why risk being too optimistic?

Bad news bears?

No doubt about it, there are plenty of reasons to be negative.  Some of the most recent headlines underscore the fragility of the US economy.  Some highlights:

Reasons for upside surprises and what to watch

While the rest of the world seems to be stuck in the summer doldrums (China’s exports are down, Greece and Eurozone struggling), the US is chugging along albeit at a slow pace. Amidst the recent volatility and turmoil, there are some bright spots:

  • Mid-cap and small-caps could continue to benefit from US investors sticking close to home.  Unlike S&P 500 companies, with roughly 40% of profits coming from outside the US, domestically oriented businesses should fare better.
  • Similarly, those large companies or sectors with a bias toward US industries and consumers should fare better overall than those oriented toward emerging markets or European economies.
  • Valuation:  And while it makes sense that domestic companies fare better, I am an advocate of considering valuation as an investment criterion.  A good long-term investment strategy to choose is investing in out of favor stocks with low price to earnings ratios that may rebound with global growth.  As shown in the chart below, Energy, Technology and Materials stocks continue to lag while those sectors that have outperformed this year may be due for a breather.   Along this same strategy, battered international companies with good long-term prospects that look cheap may be good buys now.

In the coming weeks, we will consider earnings and sector performance more closely in the weeks to come for clues regarding ongoing investment themes.  Just as the axiom says, “Buy low and sell high.


The leading sectors of the market in the second quarter are consistent with the first quarter





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Taper, taper toil and trouble

Posted by Abigail M. Huffman, CFA on June 30, 2013 at 12:55 pm


This year’s perennially aloft stock market finally took a tumble last week after Fed Chairman Ben Bernanke hinted at tapering the massive bond purchase program (aka QE3) designed to hold down long-term interest rates and stimulate economic growth.  The financial markets reacted violently and sent shudders worldwide.  Some notable statistics:

Not surprisingly too, the shoot-up in rates, which has the potential to derail the entire economy, hit housing stocks and REITs disproportionately hard.

This week: Some back-steps

Clarification by Fed officials this week (notably William Dudley of the New York Federal Reserve) has calmed roiling markets, and the US stock market has still marked double digit returns for 2013 – not bad for six months.  From my perspective, the media’s and pundits’ handwringing obscures the potential positives of Fed speak.

From a positive viewpoint, the Fed is communicating that it stands ready to gradually slow bond purchases so that interest rates normalize when:

  1. Unemployment has receded to lower levels
  2. The economy is on a self sustaining trajectory

What comes next? A focus on company earnings and what to look for

Next week marks the end of the second quarter and the beginning of company reporting season.  From a stock investors’ perspective, these are the things to look for:

  • While revenues are expected to be flat (reflecting slow spending somewhat due to the effects of sequestration muting demand), the focus on expanding margins, productivity and bottom-line profits will be key.  I would also pay attention to company guidance by large bellwether companies. What are the business challenges and opportunities on their minds? 
  • The slowdown in China and other parts of the world has lowered the cost of raw materials for large manufacturers.  In addition to the US consumer, who comprises almost 70% of the US economy, my attention is focused on manufacturing.  What are the comments from CEOs of industrial companies regarding their customers, costs, productivity etc.? 
  • Sector performanceSo far this year more defensive sectors of the economy have outperformed including Healthcare up almost 20%, Consumer Discretionary up more than 16% , and Technology up more than 12%.  The laggards have been Materials down almost 9%, Energy up 1% and Utilities at 7%.  For the last quarter, leadership has stayed somewhat the same but with Financials being in the top three leaders (along with Health Care and Consumer Discretionary.)  I would pay attention to any upcoming changes in sector leadership.

More about earnings…

Check back for more commentary about sector performance as the earning seasons progresses.  www.thehuffmanbroadsheet.com will keep you posted on important topics to consider for your investing going forward.



[1] “Stocks sink 2.1% on Fed pronouncement” by Vito Racanelli in Barron’s, June 24, 2013


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Asset allocation: Don’t forget your mid cap stocks!

Posted by Abigail M. Huffman, CFA on June 10, 2013 at 7:15 pm

Mid cap stocks have outperformed versus small and large cap benchmark indices

Although mid cap stocks are sometimes overlooked in the asset allocation discussion of how much to invest in stocks, bonds and alternative investments, they can be a meaningful contributor to portfolio returns and diversification.  The chart above shows that the outperformance by the Standard & Poor’s Midcap index compared to both the Standard and Poor’s 500 and Russell 3000, both indices of the largest companies, since 1995.  Annual average return for S&P’s Mid cap index was over 4% greater than the large companies.  Why?

First, a definition of mid cap stocks

Mid caps are less easy to define than small or large capitalization stocks – by their very nature of being in the middle.  Small cap companies tend to be defined as those valued at less than $1-3 billion (depending on the index family).  And, large cap companies tend to be well known – think of Exxon, Apple, IBM etc. –  and measured in the hundreds of billions.

In contrast, mid cap stocks may be defined as high as $15 billion depending on the mutual fund manager. Benchmark families may also define mid cap stocks differently. S&P defines mid caps as the 400 companies with market value between $1-4.4 billion.  Russell goes as high as $8 billion.

Why do mid caps outperform?

Regardless of the exact parameters of middle-sized companies on the capitalization scale, the long-term outperformance is clear.  One strategist I know prefers mid caps, describing them as small caps on their way to becoming large caps, with a stopover in the mid cap range during their high-growth phase (Note: companies, large or small can also be fast growers but mid caps seem to capture the high-growth stage more demonstrably.)  Mid caps tend to be more established – read older – than small cap companies with more experienced management teams.  Mid caps may also be attractive as acquisitions to large companies looking for growth.   And in a period where US companies are outperforming many parts of the world economy, mid caps tend have a greater proportion of domestic earnings than large multinational companies.

Your stock allocation

Mid cap stocks represent less than 10% of the equity market in terms of value.  They are a good way to increase the equity diversification in a portfolio along with large and small cap stocks.  Adding mid caps increases the breadth of equity exposure in a well-diversified portfolio.  Just like the middle child, do not overlook your mid caps.



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A picture worth a thousand words – housing rebound

Posted by Abigail M. Huffman, CFA on June 1, 2013 at 10:52 pm

Last October, I predicted that housing could to be a driver for all sorts of good things in the economy.  [See “Will Housing Provide the Growth we are looking for?“] With Case-Shiller’s latest report showing house prices advancing a robust 10.9% year over year (compared to the same period a year ago), it is clear that residential housing prices overall have rebounded from recessionary lows. See graph.

Home prices are still below their 2006 peak but have recovered to 2003 levels

Source:  Bloomberg, May 28th, 2013

As has oft been written, a rebound in housing is a positive development for many reasons.  When house prices increase, the wealth effect kicks in.  Investors feel wealthier and they spend more, which in turn causes a ripple effect (also know as a multiplier effect).  Positive related effects range from expanded balance sheets for banks, increased furniture sales for retailers, greater demand for employees at companies supplying residential goods and services etc.

In tandem with better-than-expected housing data, consumer confidence data also showed a surprisingly positive increase to 76.1, which is almost 12% higher than the previous month as reported by Bloomberg on Tuesday.  Current GDP data confirm a housing rebound and steady overall growth despite a decrease in government expenditures due to sequestration.[1]

Looking to the market: Top performing industry groups confirm broader economic healing

This year, the top performing industry groups in the stock market show greater diversification compared to 2012.  As shown in the table below, housing related stocks were the top performers taking four out of the top ten slots – no surprise there (see table below).

With 2013, some of the newcomers include Toys, Electronic Office Equipment, Business Training, Travel and Tourism, Specialty Retailers, and Asset Managers.  Increased employment and higher confidence are giving consumers the wherewithal to spend again on discretionary items. And in the stock market, confidence is reflected in the retail investor’s willingness to rotate into stocks.

Dow Jones Total Market Industry Group

2013 Industry Group Leaders 2012 Industry Group Leaders


Airlines Mortgage Finance


Biotechnology Mobile Telecom


Toys Biotechnology


Electronic Office Equipment Airlines


Business Training Home Improvement Retailers


Travel & Tourism Home Construction


Full Line Insurance Building Materials & Fixtures


Specialty Retailers Investment Services


Investment Services Full Line Insurance


Asset Managers Broadcast and Entertainment

Source:  Barron’s May 22, 2013

Animal Spirits – What next for the market?

Consumer confidence is now the highest it has been since prerecession crises.  Consumers have spent the last few years deleveraging and paying down debt.  We are now seeing the fruits of that spending discipline – along with Federal Reserve policies to stimulate economy via low interest rates – reflected in the markets as well as the broader economy.   With the rebound in housing, improving employment and gross domestic product, “Animal Spirits” are here.




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Kicking the tires of your stocks (aka “due diligence”)

Posted by Abigail M. Huffman, CFA on May 1, 2013 at 1:33 am

Annual meetings for shareholders are one part of my investment process that can add to the investment thesis: is this a good investment, why or why not?  They can also be quite fun (such as Warren Buffet’s shindig for Berkshire Hathaway.)  While most meetings are pretty straightforward, the shareholder meeting provides nuances beyond the numbers.  For the numbers, you can listen to quarterly earnings calls or webcasts, read financial statements and discuss with your advisor whether a security complements your portfolio.

I recently attended two meetings that contrasted sharply.

Company “A” – a large financial conglomerate

This meeting was held away from corporate headquarters at a midtown hotel.  Attending required walking past chanting demonstrators and passing through metal detectors.  Once in the meeting, the gathering was noteworthy for the steady stream of anxiety, dissatisfaction, vitriol and complaint expressed by shareholders – including some former employees!  Primarily these individuals bemoaned their sizable investment losses, a reverse split in shares (perhaps improving the “optics” but not much else), low dividend payout, and all around poor performance of management.

The board of directors sat to the side and barely acknowledged the sizable audience.  Management sounded bland and defensive.  After listening to ninety minutes of tragic stories about the destruction of shareholder value, I left.  It was too depressing.

My verdict: Get rid of my ten shares (formerly a hundred!) and be thankful that this speculative investment, purchased during the global financial crisis, was at least worth the purchase price rather than zero.

Company “B” – a small cap specialty chemical company

This meeting was remarkable for its pleasantness.  Held at the company headquarters, shareholders received an attractive handwritten nametag.  Employees were gracious and cheerful.  At the beginning of the meeting, each board director stood, smiled and mouthed hello.  The senior managers of different business units also stood and appeared engaged and pleasant.

The CEO was relaxed as he reviewed the outstanding performance of the company and its stock in 2012.  He was also happy to indicate a dividend increase.  The excellent management, profitability, stock performance and dividend increase spoke for themselves.  When shareholders were invited to ask questions, not one hand arose.  This was a satisfied bunch of owners!

My verdict – listen to upcoming earnings call, keep the stock and add to my position!

It is not always possible to go to shareholder meetings.  Investors can also look at company websites and listen to a quarterly earnings call (or biannual for foreign companies) announced well in advance on the investor tab of the site.  The important point is to be familiar with your investments, and to pay attention to the details.

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Green Light or Caution ahead?

Posted by Abigail M. Huffman, CFA on April 13, 2013 at 2:36 pm

Since the beginning of the year, Health Care, Staples and Utilities have outperformed the overall market

The US stock market has been on a tear in 2013 with the first quarter showing advances worthy of an entire year (average annual returns are 9-10%.)  For the oft-cited overall indices, the year-to-date gains (not including dividends) through April 11th are shown below:

Dow Jones Industrial Average: up +13.4%

Standard & Poor’s 500:  up +11.7%

Nasdaq Composite: up +9.3%

Russell 2000: up +11.5%

Source: Wall Street Journal

With such healthy returns, is it full steam ahead? Or time for the market to take a breather?

Here’s the good news

As noted in my November post, “With consumers becoming more confident, is it time for a positive feedback loop?” , increased net worth from appreciating real estate and improved employment should drive spending, economic growth and stock market advances.  In the last six months we have seen:

  • House prices rebounding to a post-recession high (See latest Case-Shiller) for March 26th.
  • Improving employment numbers.
  • Increased economic activity as measured by gross domestic product along with positive leading economic indicators.
  • More retail investors gaining the confidence to invest again in stocks.  (See Mom and Pop Run with the Bulls)
  • Safe haven investments, such as gold, languishing. (See recent NYTimes article on gold)
  • Stronger than expected corporate earnings.

Is it time for the market to take a breather?

Given this positive backdrop, what are the risks of repeating the “Sell in May and go away” pattern? The last several years, in particular, have seen the stock market advance in the early part of the year through May, and then retreat during the summer months.  While this year’s US economy is stronger than the last few years, what are some upcoming data that bears watching?

This year I am focusing on the following concerns:

  • First, as of April, we are entering the earnings season when companies report profits.  Will companies surprise to the upside despite muted expectations?
  • Also, the defensive sectors, such as health care, staples and utilities are leading the market advance instead of those sectors that usually perform during bullish periods such as materials, technology, industrials.  [Refer to chart of sector performance year to date.] Such market action may be a flashing yellow light indicating “Caution ahead.”
  • Volatility, as measured by the VIX  is at a historically low range around 12-14 (normal ranges are in high teens to low 20’s).  Are investors becoming too confident given the recent robust advance?
  • The US debt ceiling needs to be increased and lawmakers are sharply divided as to how to proceed.  A stalemate – if similar to summer 2011 – could cause the market to retrench.
  • The macro environment has been quiet lately but economies in Europe and Asia are still struggling.

Take the long view

While the market may retreat in the short term, it’s important for investors to keep a long view.  Historically over long periods, stocks have appreciated more than bonds or cash.  And for building a diversified portfolio, stocks are an important component.  TheHuffmanBroadsheet.com will keep you apprised of trends in the markets.

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Have the markets disregarded the potential effects of sequestration? Or is this the first – albeit – awkward step toward spending cuts?

Posted by Abigail M. Huffman, CFA on March 20, 2013 at 11:56 am

Where we are today
Since the beginning of March, Congress has applied automatic spending cuts (aka sequestration) to 5% of Federal government discretionary spending. Estimated to total $1.2 trillion by 2023, the cuts to discretionary spending were supposed to be so unpalatable when they were proposed that no one thought they would come to pass. In fact, sequestration was designed to compel lawmakers to make the tough choices needed to curb the growth of long-term debt and force a compromise.

Nevertheless, here we are in a sequestration world after more than two years of wrangling and numerous attempts to come up with a credible plan to reduce current spending and long-term debt growth. Starting with the rejection of Obama’s bipartisan deficit cutting commission – or “Simpson Bowles plan”, a failed “grand bargain” by Obama and Boehner, followed by several subpar “Super” committees, sequestration has become the default position until future negotiations devise an alternative framework.

Washington math and some important metrics
1. Since the last debt ceiling crisis in 2011 when Standard & Poor’s threatened to downgrade US debt if lawmakers could not propose a “credible” design for long-term debt reduction, the target long-term debt reduction has been around $4 trillion. $4.4 trillion in cuts over ten years is cited as the amount that would stabilize the debt to government spending ratio at 60% by 2023, down from today’s ratio of 72% but above a long-term US historical average of 50%. (In dollar amounts, current debt is about $16 trillion compared to a government budget of almost $22 trillion.)

2. Sequester cuts apply to discretionary spending, which accounts for less than 40% of the Federal budget. While the cuts may feel draconian to those reduced areas of the budget, $1.2 trillion over ten years is only 27% of the cuts needed to bring down the debt. According to the Congressional Budget Office, spending reductions will be about 8% for defense and 5-6% for non-defense expenditures. See The budget and economic outlook: Fiscal years 2012 to 2013

3. While the recipients of discretionary funding (such as veterans, federal employees and the park service) will feel the cuts the most, the effects of $85 billion in annual spending reductions are blunted by automatic increases in entitlement spending including Social Security and Medicare which coincidentally increases by $85 billion this year over 2012. So in the final analysis, overall government spending is still increasing but at a slower rate and may not be felt more broadly by ordinary Americans in the near-term.

Robust financial markets are focused on an improving economy
The stock market’s advance this year (over 9% for the S&P 500 as of last week) reflects robust corporate profits and improving economic conditions. Consumers are benefiting from increased employment, price appreciation in the housing markets, and growing household net worth.

Against this backdrop, businesses and consumers are less focused on government finances. The impact of federal spending, plus or minus, seems less important now that financial conditions have improved and the Global Financial Crisis has receded.

Does that mean that Washington dramas are no longer important? No, we still have the Continuing Resolution (to fund government operations) and the Debt Ceiling authorization coming up. But for now, the market does not seem to care!






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Next on the Agenda – Sequestration and the potential for rocky markets

Posted by Abigail M. Huffman, CFA on February 13, 2013 at 8:42 pm

I have recently returned from meetings in Washington DC and note that the mood is sour.  The Republicans vow not to give an inch on upcoming negotiations, feeling that they have already deviated from their “no tax” pledge.  Democrats, however, feel that more compromise is required – on the Republican side – and are determined to stand their ground too.

For investors, although the recent tax rate hikes and three-month debt-ceiling agreement have reduced some uncertainty, the next few months present numerous opportunities for legislative skirmishes and for market volatility.

Important Dates coming up

  1. March 1, 2013: Automatic spending cuts (aka sequestration) loom.  The threat of automatic cuts of $1.2 trillion over 10 years (roughly $984 billion after interest costs are saved or, $109 billion in annual savings from defense and discretionary spending) was supposed to drive lawmakers to make the hard choices for a compromise – especially since they are holding their pay hostage to a timely agreement!  However, as of this writing it appears as though each party wants blunt cuts across the board – which is what sequestration does – as a cudgel to assign blame to the opposition.  While the stakes are high in terms of ideology and the size of government, the agreed $1.2 trillion in cuts over 10 years is relatively small potatoes. A curtailment of $1.2 trillion is not enough to credibly stabilize debt growth or the critical debt to GDP ratio.  According to the Congressional Budget office, the debt to GDP ratio will rise to roughly 77% by 2023 if lawmakers cannot come up with a combination of more spending cuts and revenue raisers. [See latest CBO report][1]  Why is the rise of debt worrisome?  Because levels of debt at 90% or higher are associated with a reduction of economic growth by around 1%.[2]
  2. March 22, 2013:  Government financing has relied on a continuing resolution for the past 3 years instead of an actual annual budget.  Look for budget hawks in the House to drive spending cuts in exchange for spending authorization.
  3. May 19, 2013:  The 3-month debt ceiling agreement expires.  While the Treasury can always resort to “extraordinary measures” to keep government running for 5-6 months, we may be facing a déjà vu of the volatility witnessed last December.

Good news or bad news? 

With each party spoiling for a showdown, staying positive seems an act of bravery.  But the contrarian in me believes that bad news may be good.   According to Pew research,  “reducing the budget deficit” is now ranked #3 in terms of priorities by 72% of Americans (up from 53% in January 2009.) [3] And while the annual deficit has narrowed to 5.3% of gdp (or $845 billion)[4], excess borrowing is still adding to our accumulated $16.5 trillion debt. [Go to usdebtclock.org to see a real time running tally of all American debt.]  Assuming that politicians operate according to their reelection prospects, greater consciousness by the electorate could and should persuade lawmakers to forge a working agreement with the president in order to avoid visiting their districts empty handed.

Things for you to consider when investing money

  • While volatility may be an unpleasant feature of financial markets, investing regular dollar amounts periodically over a designated time frame (called dollar cost averaging) may mitigate your anxiety.
  • If your timeframe is a long one, considering your strategic asset allocation should be your best guide.
  • And remember, volatility can also bring the opportunity of lower prices and cheaper entry point into the market. If you keep an eye on valuations, volatility feels less threatening to overall portfolio worth.

[1] See “Macroeconomic Effects of Alternative Budgetary Paths” published February 5, 2013

[2] See Carmen Reinhart and Kenneth Rogoff’s study of forty four countries summarized in “Too much debt means the economy can’t grow”

[4] See “The budget and economic outlook: Fiscal years 2013-2023” for more details on government debt.

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What to expect in 2013 – Great rotation time?

Posted by Abigail M. Huffman, CFA on January 20, 2013 at 10:03 pm
S&P 500 as of 1/11/2013

The S&P 500 has resumed its climb after the Fiscal Cliff negotiations and optimism that the Debt Ceiling negotiations will be resolved

What to expect in 2013 – Great Rotation Time?

A few weeks into the New Year and stock markets are in positive territory.  As of this writing, the S&P 500 index is up and, companies that have reported quarterly earnings have been mostly positive with positive surprises around 68%.   While it is early in the period for company reporting, additional profits over expected have set a firm tone.  Other favorable indications of market confidence are strong volume levels and a very low reading for the VIX index.  Also known as the “fear index,” the VIX spikes up when investors dump stocks and recedes when stocks advance.  The VIX closed yesterday at 12.46, its lowest level in over five years as the S&P 500 has approached its all time high.[1] [See chart of S&P above.  Source: Bloomberg]

What is the Great Rotation and when will we see it?

Since the global financial crisis in 2008, investors’ preferred habitat has been bonds to stocks for their perceived safety.  In particular, investors have favored US Treasuries in the face of extreme uncertainty and have forgone the potential growth prospects of stocks, deemed risky assets, even as they have become cheaper (while stocks have sold for an average price to earnings ratio of 16.7 over the last fifteen years, they are currently valued at around 12.5!)  Moreover, the dividend yield on many stocks has become comparable if not greater to bonds since the Federal Reserve has whittled the discount rate to less than 1% to stimulate demand.

So with attractive valuations and dividends, it is reasonable to expect that investors would be tempted to sell their bonds in favor of stocks.[2]  This movement from bonds to stocks or vice versa is known as the Great Rotation and strategist have debated its timing since the Global Financial Crisis.  In 2012, the S&P returned over 17% last year, far greater than even the riskiest bonds.  Moreover, the US economic backdrop is improving with growth, lower unemployment and rebounding residential real estate.

Individuals still hesitate

2012 money flows show that individual investors have not been believers in the stock market and have forsaken almost $200 billion in potential profits.[3]  Data reported by the Investment Company Institute concur.  While equity markets were hitting their highs of the year, equity mutual funds saw huge withdrawals totaling over $156 billion in 2012, more that the net outflows of $128 billion in 2011.  As the market improved, individuals yanked more out of equities to chase bonds!

Chart #2 shows net outflows accelerating throughout 2012.  Source:  ICI.org

What could disrupt the momentum?

The initial week in January is the first period since April 2011 to demonstrate a preference for equities at $14.8 billion compared to almost $9.8 billion for bonds.  And while the US economy continues to repair from the Great Recession, the fiscal backdrop in Washington DC has yet to be resolved.  Lawmakers avoided the Fiscal Cliff by January 2nd but still have the debt ceiling, automatic spending cuts to discretionary and defense spending (delayed for two months) to resolve.  Look for continued coverage here in the Huffman Broadsheet.


The US economy is expanding and the stock market’s recent high (reflects renewed vitality.  While the Fiscal Cliff resolution may mute growth with renewed increases to Social Security and taxes on the top 1% of earners the Debt Ceiling drama will determine whether lawmakers are willing to risk fledgling growth with ideological grandstanding.  If they cause a growth scare or recession, this economic wound would be self-inflicted.


This week lawmakers seem eager to resolve the debt ceiling – for three months.  Whatever the outcome, the Huffman Broadsheet will be here to report the implications.  In any event, my perception is that the Great Rotation is here.

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Asset Allocation – Let the Fiscal Cliff be an impetus for a portfolio checkup!

Posted by Abigail M. Huffman, CFA on December 11, 2012 at 5:40 pm


While lawmakers attempt to resolve the fiscal cliff (15 days until year end and counting down!) this would be a good time to check in on your portfolio’s asset allocation.  Why?  Because volatility is low[1] and has the potential to increase [See chart #1.]  Moreover, stock market returns have been decent this year after underperformance in the last few years.   Portfolio allocations may need a revisit by investors who are complacent because of healthy returns and who may be making unintended bets on the future direction of the financial markets and their portfolio values.  By paring back winners that have appreciated and are now expensive on a valuation basis (such as price to earnings multiples), gains can be redeployed into cheaper assets before an unpleasant reality check or sell off.  The assumption that capital gains taxes may increase in 2012 is an added incentive.  In any case, systematic rebalancing keeps a portfolio on track.  Below I detail some important tenants:

What is strategic asset allocation and why is it important?

Strategic asset allocation is the long-term plan an investor (individual or institution) sets for financial assets based on specific goals, objectives, time frame and contributions for a set period.  The strategic asset allocation is an investment roadmap for growth that takes into account investor risk tolerance, liquidity needs, requirements specific to his/her objectives and personal circumstances (such as early retirement, need for income over growth or vice versa) and a time frame for achieving these goals.

Example:  For most of us, it is critical to have a plan for retirement so that an individual can measure over time whether the plan is on track.  Academic studies conclude that roughly 85% or more of investment returns over time are attributable to how funds are allocated among asset classes.[2]

What are some components of a successful strategy?

Diversification among asset classes:  A prospective range of investment returns over time are attributable to how investment funds are allocated among asset classes (including stocks, bonds, cash and alternatives – such as hedge funds, real estate, commodities) Of course, this assumes that asset class allocations are diversified and perform according to general market risk, as shown in chart #2, rather that specific security risk. (Security risk is associated with a company or industry.  Examples: Tobacco companies face lawsuit risk associated with the dangers of smoking.  Drug companies face the risk of patent expiration on the drugs and the competition from generics)

Allowing for time in the market as “timing” is not perfect.  While an investor may plan to ride a particular security or asset as it appreciates while vowing to jump out before a sell-off, this clairvoyance is rarely achieved on a consistent basis.  So disciplined “rebalancing” based on periodic readjustments according to a combination of price or calendar guidelines can help maintain intended allocations.

Chart #1:  Volatility, as measured by the VIX, spiked to historical levels during the Global Financial Crisis in 2008 and has subsided to below average rates in the last six months.  Source:  Bloomberg

Chart #2:  The efficient frontier curve (according to Modern Portfolio Theory), illustrates the optimal performance of a diversified asset class given its measured risk.  Source:  Investopedia

Despite the uncertainty, move forward!

Investors have had to grapple with uncertainty, volatility, and a weird investing environment in the past few years.  Interest rates are very low, inflation appears quiescent despite a huge buildup of government debt, unemployment is high and there is excess growth capacity in an economy that could ramp up if demand returned to historical levels.  Internationally, many of our trading partners are also dealing with a low-growth environment and high debt.  Is this a reason to shun the financial markets? No!

Despite the uncertainty and distressing environment, time can be on the side of the patient investor who takes a long-term view toward compounded returns and appreciation.  While nervous investors have rotated into less volatile investments (such as government bonds), there are opportunities in the market due to lower prices of risk based assets.  Set sail and move forward!



[1] According to Bloomberg, average annual volatility, as measured by the VIX index, for the last 10 years is 20.89 versus 16.85 for the last six months.  Click here for a definition of VIX.


[2] Gary Brinson’s landmark asset allocation study and subsequent academics have argued over the percentage of returns attributable to asset allocation for twenty-six years.  For a recent detailed discussion, see Asset Allocation


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