October 2013 THE ADVOCATE - Cravens & Company Advocate October 2013.pdf · October 2013 Page 1...

October 2013

A New Way to Describe What We DoWayne CravensKen Solow, CIO, Pinnacle Advisory Group

A Blessing of TimeWoody Welch

THE ADVOCATE

Climbing theWall of Worry

www.cravensco.comOctober 2013

October 2013 Table of Contents

Market ReviewRick Vollaro, CPACarl Noble, CFASean Dillon, CMTSauro Locatelli

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A New Way to Describe What We DoWayne Cravens, AIF® and Ken Solow,CFP®, CLU, ChFC, Pinnacle AdvisoryGroup

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ADVISORSWayne Cravens, AIF® - [email protected]

Woody Welch, CRPC® - [email protected]

Amanda Clark, CFP® - [email protected]

Mick Miller - [email protected]

SUPPORT STAFFSandra Wilson - [email protected]

Jaclyn Booker - [email protected]

Conlon Cash - [email protected]

Chris Owens - [email protected]

Chris Roberts - [email protected]

1080 Interstate Dr.Cookeville, TN 38501931-528-6865Fax 931-646-3619

4929 Peavine RoadCrossville, TN 38571931-484-7724

500 N. Main StreetJamestown, TN 38556931-752-2116

OFFICES

A Note from the PrincipalWayne Cravens, AIF®

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A Blessing of TimeWoody Welch, CRPC®

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A Note from the Principal

I am pleased to present the first edition of our newnewsletter. Inside you will find timely informationshared by our team, our partners, and other individu-alswhowe feel bring insightful perspective thatwe feelmay be beneficial to you.

Thismonthwewill be featuring commentary fromourresearch partners at Pinnacle Advisory Group ofColumbia,Maryland. Pinnacle has been evolving their"risk-budgeting", "go-anywhere" approach to invest-ment management since the company was founded in1993. Their talented group of investment analystsworks as a team and use a "weight of the evidence"approach to decision-making that requires a signifi-cant majority of factors in reaching conclusions. Be-cause of their unique approach, commitment to theirprocess,andtheircontinuityofmanagement,wechoseto partner with Pinnacle to bring their expertise and

direction toour "Risk-ManagedCore" strategy. Inside,youwill seemore ofwhywe think their philosophy anddistinctive approach make sense in the complex timein which we live.

We hope youwill find the information here and futureeditions to be helpful and affirming that we are con-stantlyonwatch forperilsandopportunities thatcouldimpact the success of your financial objectives.We de-sire your thoughts and feedback on this publicationand all aspects of our service. Please, don't' hesitate tocontact us with your questions, thoughts, and sugges-tions. As always,we thank you for your trust and confi-dence.

Wayne H. Cravens is the President of Cravens &Company Wealth Management.

Email: [email protected]

Sincerely,

Wayne H. Cravens


The Blessing of Time

Investment success is more often accomplishedthroughpatience than good timing.Whileweobvious-lydesire todowell inall timeperiods, our fundamentalinvestment philosophy is structured to maximize re-turns over fullmarket cycles rather than brief time pe-riods. Full cycles include both economic expansionsand contractions, historically lasting three years ormore. In a rising market opportunities are often real-ized relatively quickly. In contrast, a declining marketoften produces greater long-term opportunities, buttheseopportunities typically take longer tobe realized.

We experienced significant outperformance in 2009,2010, as well as the first half of 2011; then we saw themarket's swift decline begin a period of underperfor-mance in the summer of 2011 which concluded in thesummerof 2012.Once the tide shifted, ourprocess hasonce again confirmed its value. Many studies haveshown humans are more emotionally grieved by lossthan they are emotionally encouraged by gain. So evenwith confidence in the long term,making and then los-ing is very hard on our emotions. This time periodechoesmany before it. Investors who evaluate successovershortperiodsof timewill cometoavastlydifferentconclusions than investors who look longer term.Strategies should continually be evaluated, not basedon their yearly returns, but onwhether the philosophyis still relevant.

Sowhat's next? Seeing beyond the horizon is challeng-ing on a clear day, and far more difficult when cloudy.Many of the concerns which seemed to be thunder-clouds, such as the financial stability of Europe andAmerican cities and states, seem to have dissipated.We are hopefully entering a virtuous cycle of compa-nies needing more employees to meet demand andthose newworkers spendingmoremoney creating ad-ditional demand. The world economies also have the

potential of helping one another by having expansionsin America, the emergingmarkets, Europe, and Japanat the same time. This hasn't happened in the past 20years, but has happened before and seems reasonablewith economies gaining strength from the demand ineach other.

Currently the largest clouds come from gridlock inWashington over the debt ceiling, budget, and health-care. Since they don't knowwhat they will do, how cananyone else feel confident predicting what they willdo?Whilewe lean toward the campwhobelieves ratio-nal decisions will prevail, we realize in dealing withpoliticians and partisan politics, decisionsmay be lessthan rational. To add to the confusion, the public/in-vestors are infatuatedwith potential calamity andpre-dicting theshort term.Thenewsmedia feeds this infat-uation twenty-four hours a day, seven days a week.Since they make money by enticing people to pay at-tention, the accuracy of their forecast de jour' is nottheir main concern.

Our market health indicators are not designed to pre-dict the future but to declare when conditions are sup-portive of positive returns. Currently, these indicatorsare showing signs of opportunity. Valuation is com-pelling,MonetaryPolicy is simulative, andPsychologyis neutral. We are always considering potential shortterm adjustments, but we are not willing to do this tothedetrimentof the long termopportunity. So ifwearelong-term focused thenwhydowe trade somuch?Theanswer is thatweare long-term focusedon themarket,not on any individual company. We continually shiftthe portfolio to take advantage of where we see oppor-tunity; rotating towardcompanieswe feel offer greatervalue or are poised to lead the next market advance.Whenwe are wrong or see even greater opportunity inanother company, we don't hesitate to reposition. Put

Capital Appreciation Strategy


another way, we are active managers but market par-ticipants. We believe in the long term value of owningcompaniesasopposed to loaning themmoney throughinvesting in bonds. But a key to our long term successis repositioning the portfolio into companies we feelprovide the best opportunities. Time is a blessingwhich can smooth out the ups and downs, making thecurrentvolatilityanunpleasantbutdistantmemoryonthe road to a successful investment experience.

Woody Welch is the Director of Investments ofCravens & Company Wealth Management.

Email: [email protected]


A New Way to Describe What We Do

It is surprising how the investment industry mediafinds ‘news’ in investment methods that Pinnacle hasbeen employing for years. A June 1Wall Street Journalarticle offered a wonderful example. In a piece enti-tled, “SameReturns, Less Risk,” Ben Levisohn and JoeLightdescribedanewinvestmentstrategywhereport-folio managers handle risk by targeting portfoliovolatility instead of a portfolio’s asset allocation. Ifound this of great interest because our strategic advi-sory partner, Pinnacle Advisory Group, has been ad-vocating and utilizing this technique for close to adecade. The article identified three different methodsfor targeting volatility. It’sworth reviewing themhereand pointing out which of the three is most similar towhat we do in the management of our Risk-ManagedCore strategies at Cravens & Company.

Wayne Cravens, AIF®Ken Solow, CFP®, CLU, ChFCCIO, Pinnacle Advisory Group

Core Risk-Managed Strategy


“risk-based portfolios focus on volatility, not expectedreturns. Such portfolios change their holdings based oneach asset class’s volatility at any given time.” The firsttechnique for targeting volatility is called “risk budget-ing,”which theydescribedasbuildingaportfoliobasedon a desired level of volatility. This is close to what wedo at Cravens & Company.

The second technique is “risk parity.” This techniquechangesportfolioassetallocationso thateachasset classends up having an equal amount of volatility. To do sorequires using leverage, whichwe believe unnecessari-ly adds to portfolio risk, so while we definitely under-stand theprincipal,wewouldpasson this technique forpractical considerations.

The third techniquementioned is “risk control,” whichinvolves buying and selling stocks constantly to keepvolatility stable.Whilewedon’t call this risk control,wedoutilize the technique.With thehelpof the investmentteam at Pinnacle, we are constantly looking at volatilitymeasures like the VIX Index, which measures thevolatility of options traded on the Chicago Board ofOptions Exchange and is awell known proxy formar-ket volatility. When the VIX is spiking we are likely toconsider buying, since panic selling often offers a goodbuying opportunity for value-oriented investors. Thenotion of buyinghighvolatility and selling lowvolatili-ty isausefulwaytogoaboutmanagingoverallportfoliorisk.

In the“riskbudgeting”portionof thearticle, theauthorsput forth another old idea. Rather than constraining aportfolio to a limited number of asset classes, they sug-gest it may be beneficial to allow themanagers tomakebroader investments based on the perceived risks andthe pursuit of value. This is what we would call a “GoAnywhere” philosophy and one that has been em-ployed inanumberofourstrategies foryears. Weallowour own analysts this kind of flexibility as we consider

what to own in our Risk-Managed accounts.

With the Journal's article, we now find ourselves in thehappy position of stealing from the media another ex-cellent description for what we do.

I thinkaneffectiveway toexplainourapproach toman-aging volatility is to use a picture of five buckets of riskwhere eachbucket is incrementally larger than thenext.Each bucket represents one version of our five Risk-Managed Core strategies. The bucket names are Dy-namic Conservative (DC), Dynamic ConservativeGrowth (DCG), Dynamic Moderate Growth, (DMG),Dynamic Appreciation (DA), and Dynamic Ultra Ap-preciation, (DUA).We receive researchand recommen-dations from the analysts at Pinnacle onhow to fill eachbucketwith the asset classes that they believe offers thebest values to our clients. As I mentioned before, weapply the go anywhere approach to filling each bucket.However, the size of each bucket corresponds to theamount of risk (or volatility) allowed for that version ofthe strategy. So theDC bucket ismuch smaller than themore growth-oriented buckets like DA or DUA. Theidea is to put more volatile assets in the appreciation-oriented buckets, without overfilling any individualrisk bucket.

Theamountofvolatilityallowedineachbucket isdeter-mined by analyzing the risk or volatility of five assetclass benchmark portfolios that are designed by our re-searchpartner andeachhavedifferent asset allocations.The benchmarks range from 20% in stocks to 100% instocks.There is a lotofdataabout thesevolatilitybench-marks since we can track their monthly returns begin-ning from 1972 through the present. By tracking andand analyzing this treasure trove of data, our researchpartners at Pinnacle can make reasonable assumptionsabouthowvolatile eachofour strategies is likely tobe inthe future. So when we construct our portfolios, we’renot constrained by what asset classes we’re allowed to

According to the authors,


own, but by the volatility of the portfolio relative to thevolatility of our benchmarks.

The past volatility of the benchmark, and the currentvolatilityof thebenchmark,determinesourriskbudget.

I suspect that this is a critical difference between ourapproach and the risk budgeters mentioned in the arti-cle. Managing to a risk budget as described by the au-thors often involves a predetermined target level ofvolatility,measuredbystandarddeviation, allowed fora portfolio, and the portfolio managers are constrainedto stick to that absolute amount of volatility. We offerclient’s something similar, but the differences are im-portant. Cravens & Company clients who utilize ourRisk-Managed Core strategies sign a portfolio policystatement constrainingus to a range of volatility, not anabsolute target for volatility. The range allows us to un-derweight volatility or overweight volatility comparedto our risk benchmark depending on our view of thefinancial markets. The key is that when we have lowconviction in our market view our portfolios shouldhave similar volatility to our riskbenchmark, andwhenwe have high conviction we can have more or less riskthan our volatility benchmark.

A second important difference is that because wemea-sure volatility relative to our benchmark, there will betimeswhen absolute portfolio volatility will drift to theextremes of the range we define in our policy state-ments. In fact, during the 2008-2009 bear market, ourresearch shows that portfolios managed in this waywerelessthanhalfasvolatileastheirappropriatebench-marks for the period, but more volatile than the bench-mark when compared to most historical periods. Wethink thismakes sense.As long asCravens&Companyclients are comfortablewith their risk benchmarks, andunderstand the range of volatility that could be experi-encedover longandshort-termtimeperiods, thenusinga relativeapproachhelpsus to incorporate timediversi-fication into our investment process. However, whenvolatility is floatingat the topofourallowedriskbudgetit can produce short periods of anxiety that would beeliminated if theriskbudgetwasanabsolute fixednum-ber.

I can now tell clientsand prospects that we

are a Go Anywheremanager that utilizes

“Risk Budgets.”


The third difference between the two techniques in-volves how you forecast volatility. Pinnacle’s researchanalysts use a variety of models to simulate what thevolatility of our portfolios are likely to be in extrememarket circumstances. For example, when correlationspeak between asset classes, portfolio volatility can bemuch higher than it would be if correlations were low.A simple example would be the historical relationshipbetween stocks and bonds. Investorswould expect thatinarecessionbondpriceswouldrallywhenstockpricesfall. This obviously helps a balanced portfolio to havelowvolatility.Butwhathappens inan inflationaryscarewhen bond prices sell-off at the same time as the stockmarket?Portfoliovolatility is likely tobehigher thantheaveragehistoricaldatamightsuggest.BecauseourRisk-ManagedCorestrategiesusearelativeapproachtobud-getingvolatility, ifweownstocks andbonds roughly inproportion to our risk benchmark, we’re likely to getclose to our benchmark volatility.

But if you target absolute volatility, you have to be veryaccurate in your volatility forecast. If youwant to targeta portfolio standard deviation of 10, then you can usehistoricaldata toconstructaportfolio thatshouldbea10innormalmarkets.But ifyouareforecastingarecession,thenyouneed toallowformuchhigher standarddevia-

tions from the stock portfolio and reduce your stockownership in advance. It isn’t simple to forecast reces-sions and I suspect that many of these managers makeadjustments after-the-fact so that market forecasts arenotnecessary.Usinganabsolute target could lead to thecounter-intuitive problem of adding volatility whenportfoliovolatility is too low,andsellingvolatilitywhenportfoliovolatility is toohigh.This is aproblembecausewhenmarketsriotandvolatility ispeaking, ithashistor-icallybeenatimeyouwouldtypicallywanttobeabuyer(not a seller), whichwould actually add volatility to themix. Conversely, when investors are complacent andvolatility is very low, this would be a time to considerselling and not buying, which could actually reducevolatility.

The bottom line is that our relationship with PinnacleAdvisorGroupand their excellent teamofanalystspro-vides us with the ability manage our Risk-ManagedCore strategies with a much greater degree of confi-dence than ifweweregoing it alone.And,while Ididn’tknow this prior to reading the Journal article, I can nowtell clients and prospects with some confidence that weare a Go Anywhere manager that utilizes “Risk Bud-gets.” That sounds a lot better than being a Go Any-where manager that fills buckets of risk, doesn’t it?


With thebullmarketnowupover170%since the2009 lows,andthe economic cycle pushing five years old, some are now argu-ing that the bullmarket is a time bomb ready to implode underits ownweight.Whilewe are not positioned for amajor cyclicalbear market to break out at this time, we acknowledge that thebull market is facing myriad risks over the next couple ofmonths.

Here’sabreakdownofsomeof thenear-termchallenges for riskmarkets, and also some reasonswhywe think it’s premature toget too defensive.

Rick Vollaro

Chief Investment

Strategist

Carl Noble

Senior Analyst

Sean Dillon

Technical Analyst

Sauro Locatelli

Quantitative Analyst

MARKET REVIEW


The Wall of Worry

Right now investors are faced with an ominous-look-ing wall of worry. Consider:

• Theemergingmarketshavehadrealproblems thisyear, and some countries are facing the dangerousduo of higher inflation and higher interest rates,which are pressuring their economies andweighingonassetprices. Somefearweareborderingonanoth-er emerging contagion.• Geopolitical risk is in high gear, and though ten-sions in Syria have cooled, there is noguarantee theywon’t soonbeback.Any threats ofwar in theMiddleEast quickly get the attention ofworld oilmarkets asa super spike could choke off global growth.• Some fundamentalists believe the market is nowvery overvalued, and that higher interest ratesshouldcompress themultiple that investors arewill-ing to pay for earnings.• Interest rates have risen by over 1% and have be-gun to affect mortgage applications. Some fear therateof change in interest rates is threatening to chokeoff the housing recovery, and will weigh heavily onthe U.S. economy in the quarters ahead.• Earnings through the second quarter were slow,andrevenuegrowthwasalso tepid. Somebelieve it’sonly a matter of time before the market reprices tobetter reflect the anemic earnings backdrop.• Over the next few months, various parts of theglobe will be making some important political deci-sions. InGermany there is a question ofwhetherAn-gela Merkel’s party will be re-elected. In Japan theAbe administrationwill decidewhether or not to gothrough with a large consumption tax, and in theU.S. we will have to get through another round ofbudget negotiations and a debt ceiling debate.• October ends the “sell inMay and go away” nega-tive seasonal bias for the markets. But the last weekinSeptemberandOctoberare twoof theworstweeksof the year in regards to seasonal tendencies, so itmay not be time to sound the “all clear” yet. Someprognosticators feel the intersection of quarterlyoverbought markets and the current landscapemake for a market vulnerable to a precipitous drop.

Two major risks that were recently knocked off thetable were the changing of the guard at the FederalReserve, and the concern that the Fed might taper itsbondbuyingpolicy in theverynear future.LarrySum-mers withdrew from the nomination for Federal Re-serve Governor, and the September statement fromthe Fed made it clear that it is not prepared to end thebond buying program at this time. There are still riskssurroundingwhowill chair theFedcome January, andits surprising willingness to change stances couldleave markets vulnerable to any future hawkish shift.While these items still represent risks for themarket, itis fair to say that in the short term themarkets are feel-ingmuch less anxiety about future Fed leadership andmonetary policy.

Can the Market Climb the Wall?

Given the numerous dangers the market faces, wehave to wonder if it will be able to scale such a steepwall over thenext fewquarters.While the risks tomar-kets aren’t trivial, we believe there aremany positivesworth acknowledging. Here are a few of the factorsthat could support the current bull market.

• Domestic leading indicators of growth are strong,andEuropean leading indices are ticking up aswell.China’sPMIhaspickedupfor threestraightmonths.Resurgence in global growth in the second halfcould give a boost to markets around the globe.• Inflation is very low and gas prices are pullingback – that’s good news for U.S. consumers. Syriacould come back to the fore as a concern for oil, butsurprisingly the typical crisis playbook for oil is forit to plummet as soon as the fighting starts.• Someportionofhigher rates is a simple functionofmarginally improving economics, which don’t sup-port negative real rates as long as systemic shocksareatbayand theeconomycontinues to function.Aslong as the rise in rates reflects improving eco-nomics, markets should eventually calm down.• The trend in employment is improving slowly,with small businesses’ hiring expectations begin-ning to surgewhile jobless claims continue to steadi-ly decrease.


• Measuresofdomestic confidenceare slowly risingoff of generational lows. From a sentiment perspec-tive confidence isn’t even close to the point wherefolks are throwing caution to the wind, which is acontrarily bullish sign.• There are still some valuation measures that lookvery benign (earnings yield comparisons to fixed in-come, P/E using NIPA profits, etc.). Overall wedon’t thinkstocksarecheap,but theyarenotat levelsextreme enough to warrant a move down in alloca-tion simply due to valuation.• Earningsareslow,butmultiplesarepickinguptheslack. If confidence continues to improve multiplescould carry the markets higher.• The Federal Reserve will eventually taper assetsprices, but itwill likelybeaslowprocess;meanwhilezero interest rate policy will be pegged at zero untilemployment picks up appreciably.• Structurally the U.S. appears to be healing, withmanufacturing picking up and the discovery of alarge amount of energy on our shores.• Looking past the valley of one or two weeks thatare seasonally week in September and October, thepicture is much brighter: The fourth quarter is ap-proachingandyear end is typicallyvery strong froma seasonal perspective.

Positioning Our Portfolios: WayneCravens and Woody Welch

Thewall ofworry is largeand thereare legitimate risksto consider. At the same time, we feel that an objectivelook at the evidence shows that there continue to berisks in both directions. Thereforewe’re still investingour model strategies without significant over or un-derweights.

At present, we continue to try and balance riding thewave of liquidity and managing macro issues thatcould produce turmoil and possible opportunities.There’s no reasonwhywe shouldn’t enjoy the fruits ofthe bull market while they’re here, so long as we alsoremain vigilant of the impact ofWashington’s actionsand the divergences that typically precede cyclicalbear markets. As always, when the evidence changes,we stand prepared to change with it.


DISCLOSURES

Registered branch office address & phone number:1080 Interstate DriveCookeville, TN 38501931.528.6865

Advisory services offered throughCravens&Compa-nyAdvisors, LLC, a registered investment advisor. Se-curities and additional advisory services offeredthroughFSCSecuritiesCorporation,memberFINRA/SIPC. Listed entities on this material are not affiliatedwith FSC Securities Corporation. Securities are notobligations of nor guaranteed by Progressive SavingsBanks, are not FDIC insured, and involve risk includ-ing loss of principal.

Investing involves risk including the potential loss ofprincipal. No investment strategy can guarantee aprofit or protect against loss in periods of declining

values. Past performance is no guarantee of future re-sults. Please note that individual situations can vary.Therefore, the informationpresentedhere shouldonlybe relieduponwhen coordinatedwith individual pro-fessional advisce.

It is our goal to help investors by indentifying chang-ing market conditions. However, investors should beaware that no investment advisor can accurately pre-dict all of the changes that may occur in the market.

In general, the bond market is volatile as prices risewhen interest rates fall and vice versa. This effect isusually pronounced for longer-term securities. Anyfixed income security sold or redeemed prior tomatu-rity may be subject to a substantial gain or loss.

Indexes cannot be invested in directly, are unman-aged, and do not incur management fees, costs, andexpenses.


Youhavegoalsyouwant toachieve...placesyouhope togo...things youwant to do...people you desire to spendtime with.

These dreams have motivated you over the years toworkhardandtosacrifice, so thatonedayyouwouldbein theposition to live the lifeyou'vealwayswanted.But,more than likely, you're not quite there yet.

Fully realizingyourdreamsalso takesplanning andex-ecution to get them "over the top".

At Cravens & Company, we operate as a Multi-FamilyOffice, striving to help successful individuals and theirfamilies realize and enjoy their life goals.

Your dreams may include......traveling the world with your spouse......spending more time on hobbies like photography,or wine collecting, or cooking......living on a horse ranch in the country or a cabin inthe mountains......creating a lasting legacy for your children andgrandchildren......supporting the charities and causes that you holddear...

Or,youmaystillbefocusedoncreatingwealthandneedassistance in executing a comprehensive strategy thatgives you the confidence to spend your free time on theother things that are important to you. We can help.

At Cravens & Company, we combine comprehensiveplanning, personalized investment management, taxand estate strategies, and business planning with a

proactive, solutions-oriented mindset. The result is aformulaandaculture centeredonyour success; howev-er you define it. In the complexworld inwhichwe live,we believe anything less is inadequate.

Since 1996,we've been serving the specialized needs of:family businesses and their owners, professionals, andsuccessful retirees.Over theyears our firmhas changedandmatured,evolving fromamodelwhere the individ-ual advisor acts alone in all areas of the client relation-ship toanensembleof functional specialistswhocollab-orate on finding comprehensive solutions toour clients'unique situations.

While prudent investment advice is a foundationalcomponent of our service, we passionately believe webest serve our clients by bringing all facets of theirunique financial picture into view then helping themmake decisions in aggregate rather than isolation.

Our goal is to provide each client with the leadership,relationship and creativity needed to allow them toachievetheir life'sgoalsand,evenmoreimportantly, theconfidence to enjoy the journey. After all, what's thepoint of all theworkandworry if youdon't get the satis-faction of realizing the results?

At Cravens & Company, we have a team that is by de-sign, ready towork for you. If you have complex finan-cial issues and/or desire a relationship of this type,please contact JaclynBooker to arrange an introductorymeeting. She canbe reachedat 931-528-6865or at [email protected].

Your Financial Advocate


NOTES:

www.cravensco.com

October 2013 THE ADVOCATE - Cravens & Company Advocate October 2013.pdf · October 2013 Page 1...

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