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August 2009 Update

August 1, 2009

By Tim Chapman

In Georgia there is an imaginary line that runs from Albany through Macon to Augusta - basically bisects the state through the middle - called the "Gnat Line".  If you ever find yourself south of that line in the summer you'll understand why.  Pesky little gnats, so small you can barely see them, swarm around your face, serving no purpose other than to drive visitors crazy.  You can tell who the visitors are--they're the folks who try in vain to swat the gnats away.  Locals on the other hand just ignore them.   They expect them to be there every summer and somehow, over time, they get used to them.

(As best I can tell, gnats serve no purpose other than to cause aggravation.  I wonder why Noah bothered including two of them on the Ark and how he limited it to just two.)

Whipsaw trades - buying into the market, having to get out quickly, and then buying back in at a higher price - are like gnats.  I wish they would go away but it's not going to happen.  As a tactical money manager, whipsaws are as much a certainty as gnats in South Georgia in the summertime.  And like the gnats, the whipsaws are frustrating but meaningless.  As the market works to define its next step we continue to focus on our investment philosophy--getting a decent return when the market is good but more importantly, making sure we don't lose big bucks when the market is bad.

We've had a few whipsaw trades lately as the market made some big swings in both directions.  In early July, I wrote that many of our holdings hit their stop-loss price and were sold.  But I also mentioned that our model was still "Green" which suggested a positive expectation in the near term for stocks.

As if on cue, our stop-loss move out of the market in early July turned into the whipsaw trade we had anticipated. Stocks were weak the first few days of July but a positive upward trend re-emerged on July 9th and the last few weeks of the month were very positive.  We were able to start adding equities back to our portfolios by mid-month and we finished July with nice returns. 

There has been a lot of talk in the media from politicians claiming the recession is over.  I don't know that I'd go that far, but there are some positive signs that things are improving.  Remember, stocks tend to turn up 6 to 9 months ahead of the economy, so if you look back at the March low it's reasonable to believe the economy could be posting positive numbers by the fourth quarter of 2009 or the first quarter of 2010. 

But even if that is the case, does it mean we can throw caution to the wind?  Absolutely not.   History teaches us it is common to have cyclical bull markets - sometimes lasting a couple of years or more - in the midst of a secular (long-term) bear market.  Considering all the possible things that can go wrong during these turbulent times, it would be foolish of us to ignore downturns like we saw a few weeks ago.  Every bear market starts off looking like a simple correction. At Stadion, we position our portfolios appropriately,  always keeping a balance between safety and returns.  If we are to avoid major losses we have to accept the occasional whipsaw trade, just like South Georgians accept gnats.