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January 2010 - Market Commentary


Dont be too smart

Market Timing (Top-Down) vs. Stock Selection (Bottom-Up) January is named after Janus. According to Wikipedia: In Roman mythology, Janus was the god of gates, doors, doorways, beginnings and endings. He is most often depicted as having two faces or heads, facing in opposite directions. According to a legend, he had received the gift to see both the future and the past. Given that we have just celebrated the new near, its no wonder everyone feels they also have the gift of predicting the future. In truth, January is an absolute forecasting frenzy. It affects all of us insideand outsidethe business very differently. For us, this is a difficult time of year. Why? Forecasting markets is not our forte. As investment professionals, we are expected to bring out our crystal ball and divine the big-picture future, but you know what, that is just too much risk. For you. We believe in a more factual approach to money management that does not rely on major market forecasts. It has been shown repeatedly in empirical studies that top-down, forecast-driven approaches generally fail as a long-term investment strategy. Two researchers, Grinold and Kahn, have shown that under typical risk-return parameters, top-down market-timers need to be 25 times better at forecasting than investors who focus on bottom-up stock selection (a one-by-one assessment of companies). Its simply too high a bar to jump. Yes, you may argue that in every sample size there are a few individuals who appear to have foresightthat proverbial crystal ballbut the odds are significantly stacked against them. Its just too hard to always be that smart. So, we dont rely on the market. We prefer bottom-up investing. We also prefer approaches to money management that exploit extremes in behaviour. The reasoning is simple: when market behaviour is at extremes, that behaviour is more predictable. Since the economic fall of 2008, the market pendulum has swung wildly from one extreme to another. Under these conditions, we were willing to make some market forecasts.


Here are some examples that you may remember In November 2008, we titled our quarterly commentary Opportunity is Staring Us in the Face. We wrote: Despite the battle fought over the last quarter of investing, we firmly believe the long-term, patient investor will be rewarded and win the war. In January 2009, we titled our quarterly commentary This Is Our Moment. We wrote: It is very plausible that we retest the lows and potentially decline beyond them for a period of time. This would imply a risk of a decline exceeding 12% from current levels. Some of the more dire forecasts imply the market could decline by 25% to 30%. [however] everyone is so focused on what could still go wrong, that the possibility of what could go right is not on the minds of many. In March 2009, we titled our quarterly commentary The Sum of All Fears. We wrote: Ben Bernanke and others are clear, the moral and ethical issues around preserving the grease of the economy, banking and finance, are secondary to insuring that economic engine and financial system does not seize. ... I believe that the recent market lows are a good guide to the level of downside risk investors currently face. At the same time, the market is at a valuation that has typically led to very good long term returns. In July 2009, we titled our quarterly commentary Doubt. We wrote: The most common outlook held among investors (bulls and bears alike) is doubt over the markets next direction we believe this sense of doubt is very healthy. Today the valuation of the market is similar to levels last seen after the crashes of the 1950s and 1970s, which each gave way to periods of ten-year returns that ranged between 15 and 20 percent per annum. So, the big question: were these forecasts correct (or at least close to the mark)? Overall, yes, these forecasts have been reasonably good. That said, we have reservations about forecasting further. Why? Markets are no longer at extremes. Valuation is no longer at historical lows. The risk, the reward, the bullish case, and the bearish case for markets seem more balanced. We will thus not be making a market forecast this time around. Instead, we suggest our investors do two simple things: (1) use the yard stick of the last 5 quarters to assess your risk tolerance and risk capacity (2) make sure your asset mix is consistent with your risk tolerance and capacity If it was wrong going into the bear market, now is a good time to get it right.

Sam Pellettieri, CFA Chief Investment Officer Wellington West Asset Management Inc. www.wellingtonwest.com

The information contained herein is derived from sources which are believed to be reliable, but Wellington West Asset Management Inc. (WW) makes no representation that this information is accurate or complete. The document is delivered by WW on the condition that WW, its officers, directors and affiliates shall incur no liability whatsoever or howsoever arising in connection with the information contained herein or reliance thereon. Any opinion expressed herein is based solely upon the authors current analysis and interpretation of such information and is subject to change. This document may contain forward-looking statements, which involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forwardlooking statements. This commentary is provided for information purposes only and should not be relied upon to make any investment decisions. This material does not constitute an offer to sell or a solicitation to buy any security. Wellington West Asset Management Inc. is the manager and portfolio advisor of the Nxt Funds. Nxt Funds are available through its principal distributors Wellington West Capital Inc. and Wellington West Financial Services Inc. C4434