Insights on the Current Financial Markets September 24, 2009 | The Birth of an Asset Class OK, Back to Work. The Birth of an Asset Class Absolute Investing Defined Market Direction- Where Do We Go From Here? It's Going to be an Exciting 4th Quarter. Reflecting History: 2003 or 2008

In early 2000, the first Anchor Capital market commentary was born. I think we may have had 100 clients with e-mail addresses, and many fewer who actually read my comments. Today our distribution list is in the thousands and our comments are forwarded and posted to websites and blogs beyond that. In June I decided it was time for a break. After diligently sharing my market thoughts with clients and friends regularly for nine years, I decided to take the summer off from writing commentary. It was a nice break, but summer’s over.

I wish I could tell you it was nothing but surfing and sunshine the past two months, but we’ve actually been hard at work here at Anchor. We have spent the summer managing the explosive growth in investment accounts, forming new partnerships, and new opportunities. Of course the markets have been anything but boring this summer as well, and I have some thoughts to share.

Over the next few weeks we will be sharing with you some of the details of what we’ve been up to. I’ve stated before that I believe we are in the middle of a truly important moment for the financial markets and our economy, a period we will refer to as an inflection point for years to come. And I’m proud to say that Anchor Capital -- in a very, very small way-- has had an important role.

The Birth of an Asset Class

There are many headlines to describe the financial markets in 2008. For most investors and even investment professionals, it was their worst nightmare. Who could have predicted the failure of Bear Stearns, Lehman Brothers, Freddie and Fannie Mac, Washington Mutual, AIG, General Motors, and the entire housing market in a single year? I won’t regurgitate the headlines. You can Google them for yourself.

What’s remarkable (or not so remarkable, for students of market history) is how the majority of the investment community was caught off guard. Let’s face it, over the past decade Wall Street has embraced low cost indexing and Asset Allocation. From pension funds to IRA accounts, Asset Allocation is the single, most widely followed methodology in use today. Modern Portfolio Theory and the Efficient Market Hypothesis has been accepted from the highest ranks of academia to online discount brokerage firms. And it makes sense. It’s easy to explain. It’s easy to understand. Heck, the paper that introduced the concept received a Nobel prize.

But the past decade it hasn’t worked, glaringly so in 2008. Asset Allocation failed in 2008 right when investors needed it most.

Why?

For Asset Allocation to work, portfolio holdings must have some level of non-correlation. Simply put, portfolio holdings should move independent of each other, rising and falling at different times. The concept works in theory, but as we have long argued here at Anchor, during periods of severe market stress all asset classes become unified. During severe market declines, ALL asset classes are sold for liquidity. 2008 was the perfect example. Every asset class including large cap stocks, small cap stocks, corporate bonds, oil, gold, real estate, even supposedly “risk free” treasuries….they all went into a highly correlated free fall.

Just like insurance on your home, you only rely on protection during a disaster. In 2008 when investors needed the supposed safety of diversification the very most, it utterly failed, and it’s going to take years to repair portfolios to their pre 2008 levels. The failure of financial markets last year has returned the market and most investors to 1998 levels. A decade of investment progress wiped out.

There was one asset class however that did NOT fail investors in 2008, and has made steadily higher returns over the past decade: Absolute Returns.

Absolute Return Investing Defined

It was in 2006 that my partner Dr. Barker and I began to shift the focus of Anchor Capital from pure growth to Absolute Returns. Access to Alternative Strategies like Absolute Returns have traditionally been limited to Wall Street’s elite. Typically offered exclusively through hedge fund structures, only accredited and institutional investors have been able to benefit from these programs. After vigilant focus as a growth manager since our inception in 1994, Dr. Barker and I saw the opportunity to deliver Absolute Return programs to a broader audience, in the simplicity of a totally transparent separate account.

Our timing could not have been better. While the average investor has -30% less investment capital than they did in October 2007, Anchor Capital Absolute Return portfolios have returned from +3% to +20%, most with a fraction of the market’s volatility.

So what are Absolute Return strategies? How do they work? Why are they different from traditional investing, and why are investment professionals and pension plans scrambling to allocate to this category?

The next few weeks are going to be exciting, we have much to share with you. I told you we have been busy this summer and soon you will see why. From an entirely new Anchor Capital website launch, to Free Webinars and a New Booklet entitled “Guide to Absolute Returns”, we are going to tell you everything you’ve ever wanted to know about Absolute Returns, and how to access them. And not just from Anchor Capital.

It’s an exciting time for the markets, an exciting time for Anchor Capital, but most importantly- an exciting time for our clients. Stay tuned.

Market Direction: Where Do We Go From Here?

In our last commentary in June I spent some time illustrating the high correlation between the current market rally and the market bottom in 2003.

In comparing the 2009 and 2003 markets, I concluded the analysis with the following statement:

“While almost identical in time frame to both the 2008 and 2003 March rallies, the current market strength more closely reflects the Bullish environment of 2003. That would argue for continued market strength into the end of the year.”

Since those comments in June market prices have continued to recover, further reflecting the market environment of 2003. Even the economic backdrop is similar, as the market continues to find a way to rise despite poor economic data, including the largest jobless numbers in decades.

The reason is simple: Liquidity. The Fed has made clear its intentions to “re-inflate” the economy. Despite our broken and challenged credit system, the current rally proves our financial system is still functional. When the Federal Reserve dumps the kind of liquidity into the system such as now, stocks will react. Of course there will be a price to pay for today’s actions and stimulus. It will have to be paid for in the future. But the Fed is building a bridge to the future by liquifying the economy now. They are forcing money out of cash reserves where interest rates are zero, and into stocks. Investment managers across the country are now feeling the anxiety of missing the market lows, forced to buy.

Eventually the market will run too far to fast, but the levels it may reach before doing so are usually far beyond the expectation. The only human emotion stronger than fear is greed. So where might we start to see a slow down in the momentum?

The chart below shows S&P 500 Index. A 50% retracement of the October 2007 – March 2009 declines would be 1,124. Quite coincidentally the 1120-1150 level marked a major congestion level at the end of the 2003 rally.

It is entirely possible for the S&P to clear the 1100 level in the next few weeks/months. Unfortunately, even at 1100 the S&P 500 will still be -30% below it’s October 2007 levels, and still represent a decade of extreme volatility and zero returns.

It's Going to be an Exciting 4th Quarter

We have much to share with you in the coming weeks, including 3 exclusive webinars dedicated to Absolute Returns, and some exciting announcements about Anchor Capital. Summer was nice, but I’m looking forward to a very busy next few months.

Whether the market charges on to new recovery highs, or hits the brakes, the fourth quarter should be full of excitement and opportunity for both the Bulls and the Bears. It should be an ideal environment for our Absolute Return strategies.

To find out how to put Anchor Capital portfolios to work for you, click here.

Until next time,

Eric Leake
Chief Investment Officer,
Anchor Capital Management Group, Inc.
http://www.anchor-capital.com

Chief Executive Officer,
Anchor Research, LLC.
http://www.anchor-research.com

Anchor Capital Management Group, Inc., is a Securities and Exchange Commission Registered Investment Advisor. Opinions expressed are not to be construed as a solicitation to buy nor sell securities. *Anchor Capital utilizes a tiered fee schedule that offers lower management fees to accounts with higher balances. Any investment returns presented are calculated gross of fees utilizing actual accounts which represent a model strategy. Individual returns may vary substantially from those presented due to differences in the timing of contributions and withdrawals, account start dates, and actual fees paid. Past performance is not a guarantee or indication of future results. Presentation is for informational purposes only and no guarantee is made as to the accuracy of this information by Anchor Capital Management Group, Inc.