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For some time now, I've been summing up my big-picture take on the stock market by suggesting that (a) it's a bull market until proven otherwise and (b) risk factors are elevated. To review, the primary risks I'm referencing are the valuation metrics, which, in general, are currently at historic levels - levels that in the past have only been seen prior to monster declines.

At the same time, I have opined that big-picture issues such as valuations "don't matter until they do" (think of the "irrational exuberance" period from 1996 through March 2000). The key point is that valuation indicators are usually lousy timing vehicles and bull markets tend to last longer than investors can imagine. In other words, high valuations alone don't cause bear markets, but rather are a factor in the degree of pain the ensuing bear, once it begins, inflicts on investors.

Put another way, my take on the current market is this is not a low-risk environment. And as I've been saying for some time now, investors should play the game accordingly.

On that note, I've received a couple of questions on the latter part of my stance lately. "Dave, what do you mean by the phrase, play the game accordingly?" I've been asked.

So, given that we're in the dog days of summer and the DJIA has gone more than a year without a pullback of more than 3% (oh and by the way, volatility levels are also hovering near all-time lows), I thought I'd spend my time this morning "esplainin" what I mean...

The BlackRock Method: Win More By Losing Less

I recently wrote a piece reviewing what I will call the BlackRock approach to managing risk. Make no mistake about it; BlackRock is pounding the table about the idea of managing risk in investors' portfolios. In the presentation I attended at the end of May, the speaker noted that "downside capture" (the percentage decline a fund experiences relative to the overall market during bearish periods) has been increasing steadily for many years and now sits at all-time highs. BlackRock further suggests the one of the keys to long-term outperformance isn't beating the market on the upside during the good times but rather, losing less during the bad times. And this, dear readers, is what managing risk is all about.

Do the math, says the BlackRock gang. If you lose 50% during a bear market, you need a gain of 100% from the next bull in order for your account to recover. However, if you can find a way to lose less - say 25% - you only need a gain of 33% to get back to breakeven. And since Ned Davis Research tells us that the average bull market produces gains of 81%, well, the math is fairly straightforward here.

BlackRock's approach to "losing less" is to incorporate investment vehicles intended to do just that - lose less during big, bad bear markets. The firm has found that so-called "low volatility" indices can get the job done by staying close to the market benchmarks during bull markets and then declining less when things get ugly. As such, BlackRock encourages the use of low volatility funds in the areas of domestic stocks, foreign stocks, emerging markets, and bonds.

To be sure, I applaud BlackRock for "coming out of the closet" on the idea of risk management in client portfolios. It is refreshing to hear one of the largest money managers on the planet endorsing the approach I've been using since the mid-1980's.

Remember, generally speaking, most Wall Street firm tell us that it's "time, not timing" that matters, to be long-term, and to never, ever take our money out of their funds - because managing risk can't be done. So, to hear BlackRock publicly counter this silliness means that maybe, just maybe, fewer investors will see their "401K turn into a 201K" the next time the bears come to call.

However, I am concerned that the "low vol" space has become a "crowded trade" and therefore may not do the job if the bears show up in the near-term. Think about it. Although this bull market has produced stellar gains since March 9, 2009, it has been a very bumpy and at times, a very scary ride. Thus, I will argue that a great many investors returned to the market post crisis in a conservative fashion. In my opinion, this has helped push the low vol and high dividend paying stocks to valuation levels that exceed those of the overall market.

It is for this reason that I am a big proponent of diversification by methodology and investing strategy. Sure, low vol is certainly one approach to managing risk. But like anything else, a single approach may not work in all bear market environments. Therefore, employing multiple risk management strategies in a portfolio makes sense. Well, to me, anyway.

So, next time, I will explore three other approaches to "losing less" during the next big, bad bear market - an exposure-based approach, alts, and an oldie, but a goody: the 60/40 approach.

Publishing Note: My wife and I are closing on and moving into our new home next week. As such, I will publish reports as my time/energy level permits.

Thought For The Day:

Things turn out best for the people who make the best of the way things turn out. -John Wooden

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of the U.S. Economic Growth (Fast enough to justify valuations?)
      2. The State of Earnings Growth
      3. The State of Trump Administration Policies
      4. The State of Fed Policy


Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.


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