Alpha Power Investing Newsletter

March 14, 2014

Risky Business

Good risk-management disciplines are always intrinsically contrarian. The perfect risk-management system would be one that would sell at the precise peak of the market and buy at the precise low. Of course, this would mean that the perfect investor using this perfect system would appear to be a perfect fool at these transition points.

No matter what the system of risk management is, if it works, it contains a similar element of reverse psychology. "Buy low, sell high" is not a precept that can be followed by the majority.

The current bull market is now five years old. Most investors are enthusiastic about the stock market - could care less about bonds. The prevalent dogma about bonds is that they are sure losers since everyone knows that interest rates have nowhere to go but up.

Margin debt is at an all-time high, mutual funds are loaded up with stocks, stock market bears are in deep hibernation. Last year the S&P 500 was up over 30%. Let the good times roll.

There is, however, a slight problem.

Record high margin debt, mutual funds with low cash reserves, near-record low bearishness among investment professionals, big market gains out of all proportion to earnings gains - this is the stuff of market tops, of high risk, of mob psychology.

At the same time, corporate insiders - the smart money - are selling like crazy.

Last year, our Mid-Cap Power Index Managed Account strategy returned 17.4% net of fees. This was about half the gain of the S&P MidCap 400 Index. Our abnormally low return was due to the fact that this strategy is always in conservative, intermediate-term bonds from the beginning of June to late-October. This is part of the contrarian element in our risk-management system. We know that about half the time we will sit out a robust, advancing market during this five-month period. At the end of those years, we will look like fools to investors who focus on near-term performance.

Our rationale, however, is simple. Since 1949, from the end of April to the end of October, the Dow Industrials has been up about 56% of the time. Overall, this six-month period is slightly negative on an annual basis. Importantly, about 80% of the damage caused by bear markets occurs within this period. Since it is, in my opinion, impossible to consistently identify the May to November periods which will be negative, the prudent course is to avoid the period altogether. Over the long-term you pay no price for doing so, since you avoid most of the white-knuckle declines, like 2008.

The cause of this phenomenon is human nature. The latter part of the year tends to be robust because Wall Streets' "experts" are busy predicting good things for the New Year. This carries over through the first quarter, because public information on earnings is unavailable until April. If the experts are wrong and revise their estimates down, the market becomes more susceptible to "shocks", which investors are less willing to tolerate. This is a global phenomenon, occurring in over 30 developed markets worldwide, reflecting an identical human reaction to failed optimism by the experts.

The good news is that this is a long-term pattern which long-term investors can exploit to reduce risk and elevate return.

The history of the Mid-Cap Power Index Managed Account strategy from1999-2013 is given below. We juice up returns in the fourth quarter by leveraging accounts by 50% during three sub-periods totaling 20 days. These sub-periods benefit from seasonal strength that occurs within the small/mid-cap asset class in the fourth quarter during holidays and at the turn-of-the month. Since 1981, these sub-periods have been profitable about 94% of the time using the S&P MidCap 400 Index. This enhancement adds about 1% to 2% a year in additional return. Most of the added value, however, comes from holding conservative bond funds from June to late-October.

To read and/or download our current brochure, please go to the Programs and Performance section of our website at

Sincerely yours,

Jerry Minton, Ph.D.
1-877-229-9400, Ext. 11

Disclosure: Past performance is not a guarantee of future performance.

© 2014 Alpha Investment Management, Inc.
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