New Age Investing - Have you adjusted your portfolio for the "New Age"?

How to adjust your portfolio to new age market realities Published October 3rd 2001, by Frank R. Suess The purpose of this report is to explain how the monitoring of market cycles can improve your timing and help you recognize market opportunities. Furthermore, it makes recommendations on how you may adjust your portfolio to better address the current economic climate.

Have we reached the “bottom”? Is it the time to go “bargain hunting”? Is this only a short pause on an overall path to more wealth and prosperity? Or, have we entered a recessionary phase and extended slump with the potential for considerable worldwide economic and geo-political problems?

These are the questions on the minds of millions of private, professional and institutional investors worldwide. The proper allocation of assets over the next few years will depend on the answers to these questions. A big piece of the puzzle relates to understanding the rules and patterns of market cycles. Yes, they do still exist. And yes, they do still matter.

Over time, and despite wars, famines, occasional economic turmoil, and despite terrorism, the world keeps on growing and improving - at least from a purely materialistic perspective. However, during certain periods we may experience a setback during which it is necessary to shift from the permanent progress viewpoint to the historic correction position.

We have reached such a crossroads today. Stock markets are no longer "the place to be", and, they will not be the primary wealth creators for several years to come - even if we have reached the bottom. Booms and subsequent busts of the past serve as valuable reminders.

The surge in tech shares from late 1998 to March of 2000 ranks alongside other great asset bubbles of the past century: Dow Jones 1922 - 1935. Gold and Silver 1973 - 1986. Nikkei 225 1982 - 1995. In all cases, the rise in prices was initially rooted in "easy money", and began with some fundamental justification. As prices soared beyond any bounds of reasonable value, the financial establishment trotted out long lists of reasons why prices could keep rising. Investors worldwide were seduced by the prospect of easy riches.

GREED followed by FEAR ultimately dictates the nature of market realities and triggers the resurgence of manias and severe market corrections. When the inevitable bust came, few were prepared for the wealth destruction that followed - despite the warnings. Now, so-called experts are projecting a rapid rebound for early next year. The reality is that America has severe fundamental problems. As the U.S. economy slides into deeper difficulties, the rest of the world will not stay unaffected. Americans are sitting on an unprecedented mountain of DEBT, both private and public.

Crumbling equity markets and weakening economic activity at a time of high leverage create perfect conditions for severe "accidents". History tells us that a bear market following a SUBSTANTIAL MANIA has good chances of being a BIG BEAR.

THE SECULAR TRENDS OF THE PAST 200 YEARS

The following graph portrays the secular market trends of the past 200 years. The chart labels the ups and downs of the market with BEAR and BULL. It shows that a so-called buy-and-hold strategy can be detrimental to your portfolio during an extended bear market. Investors that did not get out at the beginning of the last secular bear market in the late 60's, waited close to 20 years to merely recover their investment!

Secular Market Trends of the past 200 years

Yes, the long-term buy-and-hold strategy will ultimately and most certainly lead to growth. However, I must ask you this: How old do you expect to get? How many years are you prepared to wait for a growth in your portfolio to occur? And, how many alternative opportunities are you willing to pass by while you are waiting?

I, for my part, prefer adjusting my portfolio for time periods of 3 to 5 years on a rolling basis, always on the outlook for changes in the primary trends and cycles. I have been out of stocks and into alternative investments since September of 2000 - and so have my clients.

MARKET CYCLES AND PHASES - MORE THAN BULLS AND BEARS

Market cycles are a reflection of overall direction of mass sentiment. No matter what economic fundamentals say, irrespective of any New Era Economy paradigm or sustainable high-tech productivity theory, in the end it is mass sentiment that directs the overall trend of all markets. In simple terms, market cycles can be defined as the rising and declining of emotional energy or pychological balances.

The emotional tides in markets are generally referred to as Bull-Markets and Bear-Markets. In reality, the Bear and the Bull are only two of a total of 5 typical market phases. In addition to the two "B-animals" there are also markets in Rotation, Transition and Roll-over. Let me briefly, without making this a thesis paper, explain the basic characteristics of the various market phases.

Bullish: Principally, a bull market exists when stocks in general keep rising overall in tandem. By the standards of traditional monetary theory and history, this has not been the case since April of 1998. We had then entered into a transitional or rotational phase at best.

Rotational: When stocks are in a rotational phase, some segments within the overall market have retained a bullish character, while others turn bearish. In this phase, by means of money flow analysis, one observes how money tends to flow from one sector to another. The total number of stocks advancing roughly equals the total number of stocks declining.

Transitional: In a transitional market the number of declining stocks versus advancing stocks will be skewed in one direction - either positive or negative. In this case, a pattern starts to develop across all or at least a majority of all sectors. A transitional phase, therefore, can be both bearish or bullish.

Rolling-over: In the rollover stage, the majority of all stocks across all sectors begin to decline. It is important to understand that in this phase, the broad indices so frequently mentioned in mainstream Wall-Street media, can still progress. However, in terms of market valuation, stocks will be moving in one direction only - down.

Unfortunately, the Value Line is no longer monitored as closely as it used to be . Markets in a rolling-over phase are the precursors of "bearish" markets. In some cases they lead to full and outright bear markets. Whether that happens usually depends on the extent and duration of the prior bull market. In the case of "manias", a REAL BEAR is more probable.

Bearish: Just like the bullish market, a bearish market is quite obvious and discernable. Most stocks are declining and most investors are suffering. Once the Bear has arrived, the list of market indicators that will reveal the bearish market is a long one. Today, it has become quite common to measure a bear market by any decline of 20% or more. In most cases, that benchmark will apply. It should not be assumed, however, that it applies to a fully-grown and primary bear market as was encountered from 1929 to 1932, for example. There, the Dow dropped by roughly 90%!

By paying attention to market patterns and key averages, the beginning of a change in primary trends, i.e. the secular market cycles can be recognized early enough to make prudent adjustments.

These adjustments need not be made all at once. As described above, mass sentiment does not change without passing through various phases. In fact, we entered a transitional phase during the first half of 2000. During that period, while some sectors were still booming, the number of declining stocks had grown larger than the number of rising stocks.

Dow Jones Industrial Average, 1999 - 2001, incl. 100-day moving average

The chart portrays the Dow's 100-day moving average. It points out the fact that the beginning of a general slowdown and transition in markets started almost two years ago. After an extended and (for many) nerve-wrecking roll-over phase, the past few months, and not only after the September 11th tragedy, mass sentiment finally turned sour, pushing us clearly into vicious bear market territory. The change is best seen in mainstream media. While only a few months ago, the terms "bear" and "recession" were hardly seen or heard on Wall Street, they are now commonplace.

STRATEGIES THAT WILL DESTROY YOUR WEALTH IN A BEAR MARKET

Whether you agree with my perspective on current markets or not, you should take precautionary steps to safeguard at least part of your wealth from erosion in case of a continued downward path.

While traditionally, an emphasis in fixed-income would suffice, the current mix of risk factors may require alternative steps. Particularly, American investors should beware of the home-based risk they are exposed to, if they do not diversify into international investments and foreign currencies.

Before discussing some of the options you have to prepare for what lies ahead, I will start by pointing out the strategies (or myths) that you ought to avoid at all cost.

The Buy-and-Hold Strategy:

This is the greatest misconception today. It has been indoctrinated for years now. However, as mentioned above, the buy-and-hold strategy will destroy your wealth in a bear market. Although stocks may do well in "the (very) long term", the greatest portion of that "doing well" is delivered during "Super Bull Markets".

Looking at the period spanning from 1900 to 1999, the total average return on equity has been 5.6%, while the returns during the "Super Bull Markets" (excluding 1900 to 1920, 1929 to 1948 and 1966 to 1981) came to 13.8%. Without these periods of extended growth, returns were negative!

Being invested at all times:

There is no reason or rule that says you need to be invested AT ALL TIMES. There are times when CASH IS KING. There are times, such as now, when watching from the sideline will be better than being invested in the wrong asset class.

The reasons mentioned for staying in an investment are varied: Some go so far as to say that there are no valid alternatives to equity (oh please!). Others trip over the barriers of surrender fees or taxes, both completely irrelevant in the grand scheme of things!

Dollar-locked Strategies:

The dollar bears great risk for a substantial correction. Therefore, the number one rule at this point in time is to avoid being locked into dollar denominated assets without the capability of rapid reallocation. Therefore, the classic U.S. safety pins (Money Market Funds, T-Bills or CD's without currency conversion or diversification capability) are not safe at this point. Only for Americans, they may be the right choice for those funds that they will need "at home" for liquidity.

Buying so called "Safe Stock":

There is no such thing as a "Safe Stock". You can pay too much, even for "safe stock"! That's because so-called safe stocks are often the most popular and, therefore, the most overvalued. Owning such stocks may increase rather than reduce your risk position, particularly in a bear market. It is noteworthy how so-called safe stocks have performed historically, for example from 1972 to 1974. Despite growing revenues and even bottom-line profits, such so-called safe stocks delivered highly negative returns: CocaCola was down 70%. GE was down 60%. General Motors was down 65%. Walt Disney was down 85%. We are witnessing only the beginning of a similar development as I write this report.

KEY ELEMENTS OF NEW AGE WEALTH PRESERVATION PLANNING

"New Age" sounds like a big word. However, it reflects the fact that we have entered a secular cycle during which stocks will not play the role of primary wealth creators anymore.

The time of "easy money" is over. As stock markets have turned less attractive, the focus needs to shift to fixed-income investments, i.e. bonds, money market funds and government papers (e.g. US T-Bills or UK Gilts). This is particularly true for that portion of your assets that you require "at home" for purposes of liquidity. For this portion, you may also consider investments in foreign CD's and currencies, depending on your home currency's strength. If you are an American investor, it is definitely wise to diversify at least part of your liquidity out of the dollar.

However, that part of your assets that you wish to stack away for the purpose of asset protection and wealth preservation - in the current climate this ought to be a considerable portion - needs to combine various additional characteristics.

A first key element of your wealth preservation strategy will be diversifying out of your home country risks, i.e. by selecting a country with a lower risk factor - or fundamental strength - that is comparatively superior to your home country. For instance, a country with huge private and public debt (like the U.S.) is not where your wealth preservation dedicated assets should be. The aspect of international diversification also integrates the element of currency diversification and flexibility.

Secondly, the "new age" will be characterized by a series of prominent bankruptcies. Increasing your attention on institutional safety is essential. Be sure that the institution you have your money with is absolutely safe. Note that government guarantees are good. However, they too will depend again on the stability of the respective government. Remember that banks and insurance companies are not safe just because they are big. One needs to have a close look at balance sheets in order to study liquidity, equity and derivatives exposure ratios.

Finally, LEGAL ASSET PROTECTION is an essential ingredient to any serious wealth preservation structure. The increasingly litigious nature of today's world, particularly in the U.S., creates additional non-market risk factors. Furthermore, history shows that during severe market crises like the current one it is not the markets that go through fundamental changes. On the contrary, while markets rise after the drop, it is common for monetary policies and social / legal patterns to go through longer lasting changes. These changes, in general, tend to decrease the level of financial privacy and liberty.

NEW AGE INVESTING WITH PORTFOLIO BONDS AND CURRENCY MANAGED ANNUITIES

There are various forms of European investment structures that allow for tailor-made solutions providing the necessary elements of a New Age Wealth Preservation Plan. Yet, they integrate various features that enable continuous investment flexibility and substantial capital gains potential without exposure to prevaling stock market risks.

One such structure is the currency managed insurance certificate. In order to benefit from medium-term to long-term currency trends, Swiss annuities and endowments allow you to periodically switch the currency denomination of your policy for minimal fees. In some cases, you may also take advantage of professional currency management services provided by a third party. In the past, substantial capital gains have been achieved by means of this investment vehicle.

Another innovative structure is the so-called Portfolio Bond, which combines the best of two worlds - banking and insurance - in a safe offshore jurisdiction. In simple terms, it is a holding structure through which the investor (or their advisor) can direct an insurance company to invest in a broad range of investments. Depending on the needs and objectives, the underlying investments can be freely selected. This enables the investor to rapidly accommodate for critical changes in market trends, such as we are witnessing now, without leaving the shelter of the "holding structure".

More specifically, the investor enters into a contract in his name with an insurance company, usually domiciled in an offshore tax haven. The insurance company opens an account with a bank selected by an investor, who in turn receives a policy from the insurance company. Legally, the investor is the client of the insurance company and the insurance company is a client of the bank. The policy value equals the value of the asset placed in the account and with good management will grow accordingly.

With both aforementioned structures, legal entities can be designated as beneficiaries. With certain insurance companies, the policyowner may be a legal entity. The person insured, however, must in all cases be a natural person.

Various benefits, in addition to improved performance, investment flexibility and wealth preservation, are obtained via these solutions:

Asset Protection: Properly structured and established in Switzerland or Liechtenstein, insurance policies enjoy legal protection from creditors. The protection is very strict and even where a foreign judgment or court order expressly decrees the seizure of such a policy, or its inclusion in the estate in bankruptcy, such an insurance policy may not be seized, except where it is considered a fraudulent conveyance. In case of bankruptcy of the owner, protection is also guaranteed since the ownership is transferred to the beneficiaries automatically. Any instructions from the original policy owner, which are forced upon him, can no longer be accepted.

Estate Planning: The aforementioned insurance policies are also well suited for making distributions separate from the policyowner's estate. Neither a power of attorney, nor a last will or certificate of inheritance is required for payments to be made upon the owner's death. Beneficiaries obtain immediate access to the funds according to the payment method chosen by the policyowner.

Tax Advantages: In most jurisdictions insurance policies enjoy substantial tax benefits, particularly during the deferment (value accumulation) period. In some jurisdictions, they are completely free of taxes until payments are taken out. Where required, the flexible structure allows tailoring to meet requirements for privileged tax treatment.

CONCLUSION

Timing the market correctly is an artform and not easily done. Particularly when the daily information overload does its best to confuse and misdirect you. Recognizing a secular trend as it evolves is the key to long-term success in your personal financial planning and investments.

There are unique solutions available, which are not widely known. Nevertheless, they will become the primary wealth preservation vehicles over the next few years.

Either in combination with offshore or domestic planning structures, they provide an opportunity to upgrade one's existing portfolio. Whatever measurement or system you use in determining your investment strategy, at this time buying or holding stock is risky. Even though you may believe that this financial turmoil is only temporary, to adjust your strategy for improved wealth preservation is never wrong. Properly structured solutions allow you to rapidly change gears and participate in the next secular bull market.