05.20 The Forest for the Trees: Portfolio Checkup

It’s easy for investors to fall into the trap of focusing too much on short-term data and other market noise and to lose sight of the big picture when it comes to evaluating portfolio decisions. For example, a recent Wall Street Journal article titled “Oil Investors Take a Closer Look at Production” focuses on trading in crude oil around the U.S. Energy Information Administration (EIA) weekly production numbers. According to an official from the EIA, the weekly production estimate is accurate within 100,000 barrels a day and the biggest production decline in recent weeks was just 36,000 barrels a day. On April 1st and 15th oil prices moved up over 5% after the EIA reported small production declines. That’s a big move in prices based on a data point of limited value since it is inside its margin of error. Oil has behaved the opposite way in reaction to storage numbers.

Other examples are big market moves on the release of employment data, or whether or not the Federal Reserve minutes include or remove a particular word. These types of statistics are by nature difficult to measure and subject to potentially large revisions months in the future.

What is more important is to try to focus on long-term trends.Take a look at the chart below from JP Morgan.

Echelon Chart

As you can see, stocks in the past have moved sideways for a while, and then moved higher, corrected, moved sideways, then moved higher. Since these sideways moves are fairly long periods of time at 10 to 20 years, the moves in any given year don’t look that big. The scale of the chart is deceptive though. The moves in a given year can be quite large both up and down. Barry Ritholtz has some good examples below.

“There are five rallies of 40 percent or greater: October 1966 for 47 percent; May 1970 for 73 percent; October 1974 for 64 percent; March 1978 for 62 percent and August 1982 for 41 percent.

Each of those rallies was followed by vicious sell offs: Starting December 1968 the markets were down 35 percent; January 1973 down 48 percent; January 1977 down 19 percent; and November 1980 down 27 percent.”

If the stock market of the future behaves like it has in the last 100 years or so, then long-term investing should work quite well provided the investor is properly diversified. The problem is that no one knows what the market will do in a given time period, and the markets cycles and the investors needs don’t always coincide. While everyone will happily accept an outsize market gain, a big draw down can be a little uncomfortable with a short time horizon. Investors need to evaluate their portfolios periodically to make sure their investments are properly diversified and the portfolio has the right risk profile for the investor’s circumstances.

If you have a portfolio that has done well (or hopefully not poorly) in the bull market of  the last few years, it might be time to have a fee-based investment professional do a portfolio checkup and see if there are any changes or rebalancing he can recommend based on your unique circumstances.

James Mathis, Managing Partner, Echelon Investment Management