Manager’s Letter 2018 Q1

In the Star Trek episode, “Loud as a Whisper”, deaf mediator Riva suffers a personal tragedy while negotiating a bitter dispute on Solais-V. A dissident kills Riva’s “voice”, a chorus of three who speak for him. Riva must now draw on his negotiating skills to turn his disadvantage into an advantage.

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After a correction, a passive portfolio requires a larger gain to break-even. The deeper the correction, the greater the gain required.

While no investor who’s long the market enjoys a correction, negotiated properly, it can be turned to an advantage. After a correction, a passive portfolio requires a larger gain to break-even. It starts a recovery at a lower value than when it began the correction.

Turning Disadvantage To Advantage

As figure-1 illustrates, the passive portfolio requires a 33% gain to recover from a 25% correction. The deeper the correction, the greater the gain required. An actively managed portfolio can turn this disadvantage into an advantage.

Let’s say in a 25% correction, an actively managed portfolio loses 20%. This loss is recoverable in a 25% run-up instead of 33%. The 5% saved in the correction turns into an 8% advantage in the rally. And psychologically, an investor is less likely to sell at the point of maximum pain – the bottom!

Corrections Since 2009

Corrections have been relatively mild since the March 2009 bottom. Only three have exceeded 15% so far (figure-2). On average, each correction retraced one-third of its preceding up-leg in one-third the time¹. A fourth underway now has already swallowed 20% of preceding gains in 4% of the time.

I submit that the 2009 bull market has not yet corrected.

The 2002-2007 bull market took 60 months to double, and less than 17 to give it all back and then some². It then took a 136% gain and another 49 months, 66 in total to break even. I am not expecting a repeat here. But I submit that the 2009 bull market has not yet corrected (green line, figure-2).

Concluding Thoughts

At Coherent, we focus on proactively mitigating downside risks by actively managing our stock market exposure. Our portfolio management philosophy and processes are continually honed to this purpose. We’ve been prepared going into the 2018 January highs, as we were in 2015.

Back on Solais-V, Riva begins teaching the warring leaders sign language. They learn to communicate with him and, in turn, with each other.

 
Warm regards,
Sargon Zia, CFA
April 4, 2018

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Published quarterly, the Manager’s Letter series primarily communicates the author and Chief Investment Officer’s personal opinion on the markets and other topics of interest to our clients.

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Footnotes:

1. A complete cycle in any timeframe is measured between troughs or lows. An uptrend is formed when the market makes higher-highs and higher-lows. Starting from a low, a rally moves to a higher peak in one leg, which is then retraced in price and time to the next higher-low in the second leg, completing one full cycle.
2. Rounding to full months. The 2002-2009 cycle was part of a larger secular bear market which started in 2000. The secular bear market consisted of declines separated by the 2002-2007 reaction rally which in whole corrected the 1982-2000 secular bull market. The full secular cycle lasted from late 1982 to early 2000.

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