December 11, 2012

One Week Closer to the Fiscal Cliff

Another week is history and we're another week closer to the "fiscal cliff."

You can't turn on the TV or surf the internet without some reference to the fiscal cliff. But, consider this. Remember all the fuss about Y2K back in 1999? Everybody was worried about planes dropping from the sky at midnight, ATMs freezing up, and the power grid shutting down on January 1. Well, the clock struck midnight and, poof, like Cinderella's glass slippers, nothing changed.

Perhaps it was all the preparation ahead of Y2K that ensured it would be a non-event. In fact, one could argue that all the upgrading of equipment and intense preparation that went into the buildup toward Y2K helped propel the economy and fan the tech bubble that culminated at the turn of the century. Then, as you may know, it was right after Y2K that the stock market went over its own cliff and fell into a bear market.

Now, here's where it gets interesting. While the overall stock market has been weak during the 13 years since Y2K, corporate earnings continued to rise. As a result, the Shiller PE10 ratio, a measure of valuation of the overall stock market, has dropped from 44 at the end of 1999 to 22 at the end of September of this year. In other words, the overall stock market is a lot less "expensive" than it was 13 years ago.

This could mean a couple things:

1. If we go over the fiscal cliff, the stock market may not fall as much as it did after Y2K because the overall market valuation level is much lower now.
2. Investor psychology and Federal Reserve policy are still wildcards. How investors and the Fed respond to whatever happens with the fiscal cliff could have a significant impact on the markets - good or bad.

No matter what happens with the cliff talks, we're keenly focused on the situation and we'll make adjustments to your portfolio as appropriate.

Data as of 12/07/12	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	0.1%	12.8%	12.5%	8.7%	-1.2%	4.8%
DJ Global ex US (Foreign Stocks)	0.9	10.8	7.6	0.7	-6.2	7.4
10-year Treasury Note (Yield Only)	1.6	N/A	2.0	3.5	4.1	4.1
Gold (per ounce)	-1.4	8.1	-2.0	14.2	16.5	18.0
DJ-UBS Commodity Index	-0.9	0.6	-2.1	1.7	-4.5	3.0
DJ Equity All REIT TR Index	1.4	17.0	21.3	18.8	3.6	11.6

THE OLD SAYING "THERE'S SAFETY IN NUMBERS," may work in some settings, but not necessarily in the financial markets. Doing what everybody else is doing in the markets might make you feel more comfortable, but it's not a way to get ahead. Famed investor Howard Marks pointed this out in his recent book titled, The Most Important Thing: Uncommon Sense for the Thoughtful Investor.

Marks said, "Unconventionality is required for superior investment results, especially in asset allocation." Further, he said, "You can't do the same things others do and expect to outperform. Unconventionality shouldn't be a goal in itself, but rather a way of thinking."

To frame this way of thinking, Marks developed the following matrix:

	Conventional Behavior	Unconventional Behavior
Favorable Outcomes	Average good results	Above-average results
Unfavorable Outcomes	Average bad results	Below-average results

Source: Howard Marks

The matrix says conventional behavior will get you average results - either good or bad. By contrast, it's only through unconventional behavior that we can be in position to achieve above-average results. But, do you see the rub here?

At times, unconventional behavior may lead to below-average results and, since you're not part of the "safety in numbers" crowd, you could stick out in an uncomfortable way.

As it relates to managing investments, striving for a mix between conventional and unconventional behavior seems like a good strategy. You don't want to always go against the crowd because the crowd is often right. But, there are times when it makes sense to take a stand, perhaps a more conservative stand than the crowd, and be a little unconventional.

If our portfolio is at times a bit unconventional, it's because we're trying to look out for your best interests.

Weekly Focus - Think About It...

"If everyone is thinking alike then somebody isn't thinking."

—George S. Patton, U.S. military leader

Best regards,
Sean M. Dowling, CFP, EA
President, The Dowling Group Wealth Management

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