On the heels of a tough month of May, stocks continued to slide through much of June. The Dow Jones Industrial Average, which declined by -7.9% during May, shed an additional -3.2% in the first week of June but rebounded +6.5% over the next nine sessions. During this period, the Dow traded on both sides of the 10,000 mark, finishing at 10,451 on the 18th of the month. But concerns over the possibility of a “double dip” recession sent the blue chip average below 10,000 once again, ending the month at 9774. For June, the Dow posted a manageable -3.6% loss.
For the second month in a row, the NASDAQ Composite Index trailed the Dow with tech stocks seeing additional selling pressure. Volatility here is back with multiple single-day declines of 3.5% or more during the month. During June, the NASDAQ lost -6.6% settling at 2109.
Other broad markets of note fared similarly during June, with the Dow Jones U.S. Basic Materials Index down -7.64% and the Dow Jones U.S. Real Estate Index down -4.87%. Bucking the trend were the Barclay’s Aggregate Bond Index (up +1.57%) and the MSCI Emerging Markets Index (up +0.30%).
The Appleton Group Composites™
In early May, I wrote that the market environment through the end of April was normal, and that fluctuations in prices that had occurred during the first five months of the year were reasonable. However, the markets have presented us with a dramatic about-face. Volatility has returned in earnest, predictability is low, and much of the market action over the past two months has been driven by justifiable uneasiness. We finished the month of June with significant cash and other defensive positions in all of our portfolios with the expectation that the current deteriorating market trend will unfold into a sustained downward trend.
As The Appleton Group Wealth Management Discipline employs a trend-following strategy (which is significantly different and more advantageous than a trend-predicting strategy), it has always been normal for us to be a bit behind breakeven in any year. In fact, over the ten-years of our strategy’s existence, we’ve lagged the markets at some point in seven of those years. That’s not to say that we always remained behind; rather, it is normal that during the early stages of a market reversal (and this is certainly unfolding as one) we may be behind breakeven for just a bit. Trend following strategies like ours rely on the presence of a sustainable trend, and so far in 2010 no such trend has truly emerged. Yet.
As is also true with our discipline, we’ve been successful at limiting calendar-year losses during uncooperative markets to single-digits in all of our core portfolios (Appleton Group Portfolio, Appleton Group PLUS and Appleton Group Tax Managed Growth) without exception. Such has been the case so far this year as well, although 2010 has not been without its share of uncertainty. As of the end of June, all of our core portfolios (as well as all of our asset allocation portfolios) are down by only single digits with another six months still to go. It has certainly been typical of periods of market uncertainty to unfold into a useful (and sometimes highly dramatic) sustained trend, either upward or downward. With our significant defensive position, we are poised to largely “tread water” for a time until further portfolio adjustments are warranted.
Henry David Thoreau wrote, “It’s not what you look at that matters, it’s what you see.” Every professional investment manager is always looking at the same data as everyone else, but not everyone uses the same tools to focus in on what’s truly important. Look at any current chart of any at-risk asset and it is clear that the advancing trend that started in earnest last summer is at best losing steam and at worst beginning to reverse. The effects of the multi-trillion dollar global stimulus package have run their course, and it is becoming apparent that without additional stimulus the economy may indeed falter. But with the global appetite for debt-fueled growth now waning, the overwhelming response from our government leaders is “enough.” At the recently concluded G-20 summit, countries from Europe to Asia recommitted themselves to reducing spending, and thus reducing debt. This is bad news for a global economy that’s built on the premise of unending consumption and development and growth. It could also be very bad news for the bulls who’ve arguably squandered the last two years hoping for a return to the go-go days of old and haven’t thought about the consequences if those days are indeed over.
It appears that for the next three years global government spending will decline markedly, and the consequences to capital could be dramatic. Without the support of additional stimulus, invested capital could easily decline toward levels seen during the March 2009 lows (when the Dow touched 6700). This would place the overall broad markets approximately 30% below current levels. Almost assuredly, a second wave downward could put enormous pressure on already strapped households, push unemployment well above 10%, and create gaping holes in already porous state budgets.
But here’s what it could also mean: THE GREATEST WEALTH TRANSFER IN THE HISTORY OF CAPITALISM. (I don’t think I’ve ever put ANYTHING in all caps in over 8 years of writing these market commentaries, until now). If the global economy were to fall into a double-dip recession due to the austerity measures being supported by Europe, Japan, China and others, those investors that retain their at-risk positions without making the necessary adjustments could easily see the value of those assets fall by as much as 80%. Why this figure? Because it is exactly the depth of the declines experienced by the Dow Jones Industrial Average from May 1930 through July 1932, the last time that global governments (including the U.S.) choose debt reduction over stimulus following the bursting of a debt-fueled bubble. The path being taken is clearly the same – why would we expect a different outcome?
If the current emerging trend unfolds in a predictable fashion without interruption, it would mark a significant transfer of wealth FROM those who have chosen to ignore history TO those who have chosen a more flexible and responsive path (such as trend-following). We remain committed to staying on the right side of the market as long as possible, with a high degree of asset flexibility, with an eye on both favorable and unfavorable markets, and with the knowledge that the next significant move in the markets could make a huge positive difference in the financial lives of our clients and investors.