Friday, September 4, 2009

Do You Hear That Sigh of Relief?

The stock market has come rocketing off the March 9th lows and the rally is now at 50%+ and counting. Buy and Hold investors who had been holding their breath and hoping that something positive would occur in the markets to rescue their portfolio are wondering if their prayers have been answered. Even though the S&P 500 is trading 35% below its October 2007 peak, and is still trading below its March of 2000 value, and even though portfolio returns have dramatically underperformed any reasonable and conservative estimate of growth for a decade, you can hear the strategic buy and hold crowd breathing a huge sigh of relief.

50% market rallies do a wonderful job of helping investors take their eye off the ball. While six months ago the media was screaming that buy and hold is dead, now that story is being put into mothballs while writers scramble to cover the next bull market. How sad. The buy and hold is dead story has nothing to do with short-term market fireworks in either direction, and everything to do with a theory that supposes that such extreme market volatility shouldn’t be happening in the first place. Active portfolio management is all about understanding the intersection of traditional market valuation, economic cycles, and investor behavior as measured by market sentiment and market breadth. It is worth repeating that classic modern portfolio theory and the efficient markets hypothesis (buy and hold) refute the need for any of the above. In theory, buy and hold investors can sit back and wait for anticipated returns to appear right on schedule, which is some unspecified time in the future. This remains a dangerous strategy for investors.

I am personally enjoying returning to my former status of investment genius as the bull market continues. The 2003 – 2007 bull market seems like it occurred a long time ago and I am not immune to feeling great about excellent year-to-date portfolio returns. But cyclical rallies in secular bear markets do not make the case for buy and hold investing. These are the rallies that need to be invested with caution and respect. Buy and hold investors who are just now looking up to see if the coast is clear just might be heart broken as structural headwinds inevitably crush buy and hold returns in a continuing secular bear market.