The Markets

Over the course of the last month, the global equities markets have fallen into a deep funk, dropping to market levels first seen back in 1998. Through last Friday, the Dow is down -36.3% for the year, the S&P 500 is down 38.8%, while the NASDAQ composite has lost -37.8% of its value. Over both the short-term and the long-term, the market pullback has been dramatic. The reality is that all market gains achieved over the past decade have been wiped out, at least for now.

The depth of the market losses has been substantial, but so too has the breadth. Growth stocks, value stocks, domestic and international equities, commodities, many forms of fixed income assets, real estate and seemingly safe hedging strategies have all suffered mightily. For many investors who lamented the fact that they’ve missed out on many of the market’s gains during the late 1990’s, the markets have offered an opportunity to try it all over again.

The Appleton Group Composites™

Over the last month, most of our firm’s core growth portfolios have risen in value while the rest of the global markets have dropped by nearly 20%. From August 31, 2008 through October 10, 2008, The Appleton Group PLUS Composite has increased by approximately 0.10% while The Appleton Group Tax Managed Growth Composite has increased by approximately 1.0%. All of our asset allocation portfolios have dropped less than half that of their respective benchmarks, and are largely down less than half that of the overall markets. Our significant positions in cash, treasuries and bear-market mutual funds have delivered substantial portfolio stability during one of the most unstable market environments in four generations. All of our core investment composites have successfully limited portfolio losses to single digits, while our asset allocation portfolios have performed only slightly worse.

There is no denying the reality that markets don’t always go up. Yet the overwhelming majority of money managers still only invest with the belief that A) markets always DO go up, and B) you can diversify a portfolio by holding varying kinds of at-risk assets. Both assumptions are false. I’d like to take just a moment to address both.

First, it is clear from recent experience (and history itself) that indeed markets sometimes rise and sometimes fall. Over long periods of time, it is true that the prevailing winds have favored rising markets, but only because we’ve been in an extraordinary period of domestic and global economic expansion, which as a consequence has led to a rising market. Take away economic expansion, and the investment markets have nothing to sustain its own upward momentum. This is perhaps the most painful aspect of the downturn we are now experiencing. If too much growth is compressed into too short a period of time (such as the late 1990s and 2003-2007), the inevitable slowdown in growth can have a multiplier effect in investment markets. The bear market of 2000-2002 taught that this is exactly the case: the U.S. economy only contracted by 0.60% in total during the last recession, yet the S&P 500 dropped by more than 44% from peak to trough. On the flip side, when the economy expands at a rapid pace, the multiplier to equities on the upside is equally strong: from 2003-2007 the U.S. economy expanded at approximately a 3.3% annual clip, yet the S&P 500 rose at a 13.48% annual rate.

The second assumption that we believe is largely incorrect is that a portfolio can be adequately diversified by holding various kinds of at-risk assets. For example, a portfolio that is comprised of various kinds of equities (small cap and large cap and growth and value and international and domestic stocks) and commodities and real estate and fixed income and any other asset that can fluctuate and possibly default (in the case of bonds) are AT-RISK. None of these assets can be expected to be insulated from significant and catastrophic declines in value at all times, and the current environment is evidence of this fact. All at-risk assets are correlated right now, they’re all falling and the biggest mistake that investors (and many advisors) are making is assuming that their portfolios are well diversified when the reality is that many portfolios are not.

Here’s where the rubber meets the road: There are only TWO broad asset classes: 1) At-risk assets, and 2) risk-free assets. That’s it. Right now, portfolios that hold most or all at-risk assets are experiencing significant declines because the reality is that they’re not as well diversified as the theory would dictate. What every investment portfolio desperately needs is the ability to adjust its asset mix between at-risk assets (of all kinds) and risk-free assets. That’s exactly what The Appleton Group Wealth Management Discipline does, in real time, as market conditions change. Portfolios that have this feature as a significant portion of the overall assets (as ours do) have the ability to more successfully navigate both favorable and unfavorable markets. Portfolios that lack this feature are subject to periods of staggering losses, minimal returns over long periods of time, and the real likelihood that these portfolios will fail to provide the kinds of income and benefit that the owner expects.

There is a better way to invest, The Appleton Group Wealth Management Discipline, that favors flexibility over rigidity, preparation for both cooperative and uncooperative markets, and that works to meet long-term portfolio growth expectations with as little risk along the way as is absolutely necessary.

Looking Forward

We see two distinct possibilities going forward, each of which must be prepared for and can be best navigated with flexible portfolios that prepare for both cooperative and uncooperative markets.

It is our belief that we are certainly in the midst of a sea-change in global markets, perhaps in many of the structures that have been built over the past several generations. This can create unbelievable opportunities for future portfolio growth whether the markets happen to participate along the way or not. We believe that the kinds of momentum-based markets (both up and down) that have been experienced globally over the past fourteen years are here to stay, and that the long-term trend for the markets as a whole are likely to be flat at best. As a result, buy and hold strategies (such as pure indexing, static asset allocation portfolios, target-date retirement funds, etc.) are failing strategies, and will result in portfolios that will ultimately cannibalize themselves. This includes large pensions, college endowments, insurance pools, community foundations, and most of all will include the overwhelming majority of recent and future individual retirees. Under this scenario, global growth slows dramatically, incomes are reduced sharply, and the consumption that has been such a staple of our global society will return to historic norms. One notable feature of this scenario is a global deflationary period in which the demand for basic materials is sharply reduced over the long term.

The second scenario that is just as plausible, we believe, is that the increased efficiencies in lending and production that are likely to come about as a result of this period of transition will lead to a long-term and sustainable increase in global standards of living. While growth in China and India and many other emerging markets has ground to a halt, our global banking system is sure to make future development attractive once again due to lower global interest rates. This could once again re-inflate our global economy, spur future consumption, and create a renewed upward inflationary spiral. The long-term human spirit rewards industry and entrepreneurship, and the desire to produce more efficient and profitable engines of growth is hard to extinguish. Getting the markets back to breakeven will quickly make society once again forget the importance of managing risk along the way, but the net effect of that win could propel the markets ever higher, even without significant harm to our environment and to ourselves.

Each scenario is equally plausible, and the eventual unfolding of one (or both) of these will become evident over the coming months and years. Flexibility will be required to successfully navigate each.

For Investment Professionals

There is never a bad time to get more efficient and more flexible. Adding The Appleton Group Wealth Management Discipline to your clients’ portfolios is easy, and can be accomplished in as little as a day. Adding any of our managed portfolios and/or funds demonstrates to your clients that you understand the importance of flexibility, of prudent risk management techniques, and that you recognize that there is a better way to address the realities of today’s markets. More and more advisors are discovering the benefits of adding The Appleton Group Wealth Management Discipline to their existing practices – you can too. Our suite of managed portfolios is fully GIPS compliant, fully transparent, and has a complete performance history spanning a full market cycle (which now includes two bear markets). Importantly for your clients, the performance of our most popular offerings can be viewed online, in real time at practically every financial website online. For complete portfolio performance information, please visit