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The Perfect Opportunity?
Summary:
- Our Investment Strategy has now shifted from Defensive (Preservation of Capital) to Offensive (Growth of Capital) as we believe we are past the risk of a Global Financial Armageddon and are in the "trough" of a long recession.
- The fear and risk-averse psychology that has gripped the world for much of the past year has driven down prices on many fundamentally sound businesses to very compelling levels making now a good time to buy them.
- We are patiently looking for the right time to shift some of the investments we have in short-term US Treasuries into global stocks and other securities we view are undervalued.
- In our conservatively managed "Flexible Income Portfolio" we anticipate adding a modest amount to our stock investments over time, perhaps up to a total of 30% or so.
- In our aggressively managed "Flexible Growth Portfolio" we anticipate adding a significant amount to our stock investments over time, perhaps up to a total of 70% to 90% or so.
- We do not think the recession is over yet. To the contrary, we believe we have a ways to go before the economies of the world stabilize, and we anticipate a steady flow of bad economic news and continued market volatility through 2009.
- We are aware that in the months ahead the "cheap" securities we purchase could very well become "cheaper". But it is our belief that the investments we make in 2009 are likely to produce impressive returns three to five years from now.
FROM DEFENSE TO OFFENSE
Our defense came onto the field starting in April 2007 when we suggested in our letter to clients that "..there are many risks on the horizon threatening to form into the Perfect Storm." Our course of action was to slowly start reducing our overall investments in stocks and add to our investments in short-term US Treasury Bonds.
At that time, our actions ran contrary to popular opinion and a euphoric emotional climate that predicted the markets would continue to go higher for many years. In fact, the market (DJIA) did continue to go higher for awhile longer peaking at over 14,000 in October of 2007.
In our letter to clients in November of 2007 we were further convinced a major storm was on the horizon and the market (DJIA) was unlikely to hold its recent highs. "......slowdown is due to the "domino effects" we are seeing from the on-going fallout from the losses in the Subprime lending markets. We are seeing signs that the Subprime lending issues may be "the canary in the coal mine" for a much broader segment of the credit markets, and that the losses in these credit instruments could eventually slow growth in the global stock markets as well."
Our concern that the financial markets were headed for some major turbulence peaked in late February of 2008 when we sold most of our remaining stock holdings in our two Managed Portfolios. ".....we are currently invested with approximately 70% - 80% in one-to-three year US Treasury Notes, and approximately 20% - 30% in the broadly diversified, Blackrock Global Opportunities Fund."
These aggressive actions have served our Managed Portfolio investors very well during this on-going financial crisis by limiting account value declines and avoiding permanent loss of capital.
CONNECTING THE DOTS
Today we find ourselves in a very different environment from when we were sellers in 2007.
While the worst of the economic decline may be over from a sense of panic and the risk of a collapse of the global financial system, we remain in the midst of the deepest economic recession of our lifetimes.
As a quick review, one year ago the Dow Jones Industrial Average (DJIA) traded in the 13,000 range. By November of last year it had dropped in a panic to the mid 7,500's, but then quickly rebounded by January 2009 to about 9,000 lost in the optimism surrounding President Obama taking office. But by early March, in an even greater panic, the DJIA sold off to a 6,550 only once again to rally back to recently trade over 8,400 on the hopes that the worst is behind us and the pace of the economic decline is slowing.
Stock markets usually rally before economies improve, because investors see the promise of future profits before the statisticians document a turnaround. There is a possibility this is happening now, but many rallies fizzle into nothing. Between 1929 and 1932, the DJIA soared by more than 20% four times, only to fall back below its previous lows. Today's crisis has seen five separate rallies in which share prices rose more than 10% only to subside again.
The current rally has provided a welcomed emotional relief, but we are concerned it could also be short-lived and that current levels of confidence are fragile and may prove premature. We are concerned that the glimmers of hope that have sprouted up are being misinterpreted as the beginnings of a strong recovery when all they may really be showing is that the rate of economic decline is slowing.
We are in the midst of a "balance sheet recession" and history suggests that such balance sheet recessions tend to be long and choppy and that the recoveries which eventually follow them can be feeble.
But when we step back and connect the dots between what has happened in the past year economically and emotionally, what we see forming now is "The Perfect Buying Opportunity".
We know there are countless unsolved challenges ahead for the economy, but we believe the biggest risks are now behind us. Consequently, we believe that NOW is the time to start repositioning the Managed Portfolios for the years ahead.
We anticipate and are hoping for a continuation of large swings in the financial markets over the next 12 months, and will attempt to make sound investments during these moments of market weakness.
OUR STRATEGY
- Buy on market weakness and slowly increase our allocation to stock investments.
- Concentrate the number of our actual investments but expand our holdings to companies outside the US, specifically Japan, China and other parts of Asia.
- Invest in assets that may benefit from a weaker US Dollar.
- Invest in companies outside the reach of the US Government and who are outside industries targeted for substantial regulatory change.
- Invest in companies that have little or no dependence on financing from the Capital Markets for survival.
- Invest in assets that may do well in an inflationary environment.
- Invest in fundamentally sound companies whose price has been beaten down by the general market declines.
- Keep a three- to five-year investment horizon in mind as our progress will be non-linear.
Winston Churchill once said, "You can always count on Americans to do the right thing - after they have tried everything else."
America is trying everything imaginable to combat this crisis. Some of the solutions will gain traction and some will go down in history under the category of "widely accepted bad ideas". But eventually, we WILL work our way through this mess.
Years from now when we look back at how bad things looked in the trough of this recession, I think we will be pleased we had the courage to step up and make some sound investments at the right time.
Thank you for your continued trust.
Craig P. Kelley Sean P. O'Hara
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* Performance information stated above is for the one year time period, January 1, 2008 through December 31, 2008, from December 31, 2008 through January 31, 2009, and from inception, March 31, 2006 through January 31, 2009, as is indicated. Performance information is for Kelley Investments Managed Accounts Program where client accounts are managed on a discretionary basis. Not all accounts managed by Kelley Investments are part of the discretionary Managed Accounts Program. Performance information stated above does not pertain to any accounts that are not part of the Managed Accounts Program. Performance results for accounts that are not part of the Managed Accounts Program may differ significantly. Performance information quoted above represents past performance and is not a guarantee of future results. Performance information is quoted on a Gross basis and does not include deductions for management fees or trading expenses. If these fees and expenses were taken into account, performance would be lower. The investment return and principal value of investments in the Managed Income & Growth or Managed Growth Portfolios will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost.
**For illustrative purposes only. It is not possible to invest directly in an index. Comparisons with the S&P 500® Index are not meant to be indicative of any of Kelley Investments Managed Portfolio strategies, asset composition or volatility. Given the wide scope of securities held by S&P 500, it should be inherently less volatile. Our results may differ markedly from those of the S&P 500 in either up or down market trends. The performance of the S&P 500 is shown with all dividends reinvested into the index and does not reflect any reduction in performance for the effects of transaction cost or management fees.
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Craig P. Kelley offers Investment Advisory Services through Kelley Investments, A Registered Investment Advisor. Client assets are held in custody at Fidelity Investments clearing firm, National Financial Services LLC (NFS).
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