Half & Half: Why Rowing Works Reprinted with permission from Mauldin Economics

For today’s special Christmas Eve Outside the Box, my good friend Ed Easterling brings us pearls of wisdom on the subject of rowing vs. sailing. “Rowing?” you ask. “Sailing?” And, you’re thinking, “I would surely prefer to be a sailor.” Well, not so fast. Let Ed explain why putting your back into your investing process can pay off handsomely. A nice piece to think about as you are mashing the potatoes or icing the cake. You can see more of Ed’s marvelous work at www.crestmontresearch.com.

Sometimes with all the news of disasters, wars, and plagues, we forget that the human experiment is still fundamentally intact and advancing. My great friend Louis Gave shot me a note sharing this optimistic thought in his Christmas greeting:

The United Nations recently released a heartening update on its ‘millennium goals’ for the developing world, with many of its 2015 targets on the way to being met, or indeed already met. The target to halve the number of people living on less than US$1.25 per day was achieved in 2010; the proportion of undernourished people fell from 23% of the developing world in 1990-92 to under 15% in 2010-2012; more than 2 billion people gained access to improved sources of drinking water. The list goes on but suffice to say that never in history have so many people across the globe lived so comfortably. This reflects the fact that with global GDP set to exceed US$74 trillion this year, never has the world produced this much.

New energy production (and new forms of energy), robotics, nanotech, the second (or is it the third?) wave of the communications revolution, and the amazing discoveries in biotech are all unfolding before our eyes. Global trade is expanding, and slowly but surely governments are changing. An ebb and flow thing, to be sure, but the tide is clearly lifting more boats than ever.

Just this morning I read of a new type of muscle/motor that is amazingly small yet 50 times more powerful than human muscle, a potential new cancer drug/cure going into human trials next quarter, and another breakthrough in computer cycle speeds. Moore’s Law is safe for a few years!

But the old values are unchanging, of course. And they are still the ones that bring us true pleasure and joy. The love of family and friends, those deep conversations that bring insight and clarity, a well-told story, and a perfect tomato. A new TV may amaze, but the light in a child’s face brings a joy that is unmatchable.

Thanks for sharing this past year with me. I value your time and attention, in a world where our time is increasingly focused on more and more “stuff” and where we seem to be drinking information through a fire hose, constantly confronted with facts and “knowledge” rather than savoring the flavors of wisdom and insight.

This week I cook twice, with most of the family coming for Christmas Day and then the “official” family Christmas on Saturday when all the kids can come in and be together. And you enjoy your holidays as well!

Your feeling content analyst,

John Mauldin, Editor
Outside the Box

[email protected]

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Half & Half: Why Rowing Works

By Ed Easterling

December 23, 2013

Copyright 2013, Crestmont Research (www.CrestmontResearch.com)

So you’re in line at Starbucks. The guy in front of you orders a drink that takes longer to explain that it does to consume. You want a drip…with room in the cup for milk. Then YOU take longer to decide whether it’ll be cream, half and half, or some watered-down version  of the natural product from cows. Decisions, decisions…

This article addresses two key questions for investors today: why do secular stock market cycles matter and how can you adjust your investment approach to enhance returns? The primary answer to the first question is that the expected secular environment should drive your investment approach. The investment approach that was successful in the 1980s and 1990s was not successful in the 1970s nor over the past fourteen years. Therefore, an insightful perspective about the current secular bear will determine whether you have the right portfolio for investment success over the next decade and longer.

Now, assume for a moment that you must pick one of two investment portfolios. The first is designed to return all of the upside—and all of the downside—of the stock market. The second is structured to provide one-half of the upside and one-half of the downside. Which would you pick? Which of the two would you have preferred to have over the past fourteen years, since January 2000? (Note: the S&P 500 Index is up 23% over that period.) In a secular bull market, the first portfolio—with all of the ups and downs—will be most successful. In a secular bear market, however, the second portfolio of half and half is essential. More about this shortly—and the insights may surprise you!


Why should anyone take the time to assess the secular environment when investors are so focused on next quarter’s (or month’s!) account statement?

Steven Covey writes in Seven Habits of Highly Successful People:

Once a woodcutter strained to saw down a tree. A young man who was watching asked “What are you doing?”

“Are you blind?” the woodcutter replied. “I’m cutting down this tree.”

The young man was unabashed. “You look exhausted! Take a break. Sharpen your saw.”

The woodcutter explained to the young man that he had been sawing for hours and did not have time to take a break.

The young man pushed back… “If you sharpen the saw, you would cut down the tree much faster.”

The woodcutter said “I don’t have time to sharpen the saw. Don’t you see I’m too busy?”

Too often, we are so focused on the task at hand that we lose sight of taking the actions that are necessary to best achieve our goal. With investments, the goal is to achieve successful returns over time. We should not be distracted by a focus on this week or month; we need successful returns over our investment horizons—which often extend for a decade or two…or more.

And this is where Starbucks, Covey, and secular cycle strategies converge. Investors are too often tempted to focus on immediate returns. In periods of secular bull markets, that’s fine. But today, in a secular bear market, reach for the half and half. Take the time to assess the goal, as Covey emphasizes, and sharpen your investment strategy.


Over the past 14 years since 2000, investors have repeatedly learned the lesson of falling back to, or recovering up to, breakeven in the market. While there’s no better feeling than coming from behind to breakeven, it’s a very bad feeling to watch a gain wither to a loss. But investors did not need to experience the same rollercoaster performance in their investment portfolios that the overall market traversed.

Some portfolios—generally it’s the ones that are indexed to the market using exchange-traded funds (ETFs) or mutual funds—have “participated” in the market’s ups and downs. That’s fine; such simple participation is what those funds are designed for. And that works great in secular bull markets like those of the 1980s and 1990s. But it does not work well in secular bear markets like today’s.

To illustrate, assume that the market drops by 40% and then recovers by surging 67%. An investor with $1,000 will decline to $600 and then recover to $1,000. So if you take the full cream option—all that the market gives—the illustrated cycle provides a breakeven outcome.

Chapter 10 of Unexpected Returns: Understanding Secular Stock Market Cycles(which has just been published in most eBook formats like KindleiPad, and Nook) contrasts the concept of a more actively managed and diversified approach to the more passive, buy-and-hold approach to investing. The chapter explores the concepts with the boatman’s analogy of “rowing” versus “sailing.”

Sailing is analogous to the passive investment approach of buy-and-hold—the use of ETFs and certain mutual funds to get what the market provides. Rowing, on the other hand, seeks to capitalize on skill and active management. Rowing uses diversification, investment selection, and investment skill to limit the downside while accepting limits on the upside. When the stock market plunges, portfolios built by rowing generally experience only a fraction of the losses suffered by those dependent on sailing. The expectation, however, should be that the “rowing” portfolios will also experience (only) a fraction of the gains.

The investment industry analyzes such fractional performance by assessing the so-called down-capture and up-capture of securities or portfolios. In other words, when the stock market declines, down-capture is the percentage of the decline that is reflected in your portfolio. If your portfolio declines ten percent when the market drops twenty percent, then your portfolio has a down-capture of fifty percent. Likewise, for market gains, up-capture is the relative percentage of your gains to the market’s gains.

During choppy, volatile, secular bear markets, most investors want little or none of the declines, but they want much or all of the gains. Beat the market! Other than for the luckiest of the market timers (which usually enjoy such success for fairly short periods of time), such a strategy is not realistic over most investment horizons. There is a more realistic expectation, however, that does fit with many risk-managed and actively managed portfolios.


Returning to the previous illustration, a portfolio structured to limit downside risk while participating in the upside would have fared better than breakeven. Although most investors seek somewhat less than half of the downside while achieving somewhat more than half of the upside, let’s assume that you have a half and half portfolio—50% down-capture and 50% up-capture. As the market falls 40%, your portfolio declines 20%—from $100 to $80. Then as the market recovers 67%, your portfolio rises by just over 33%. Your $80 increases to almost $107. So while the market portfolio gyrated from $100 to $60 and back to $100, your portfolio progression was $100, $80, and then $107.

Even better, consider the impact across multiple short-term cycles. The typical secular bear market has multiple cyclical phases—and there will be more of these cycles before the current secular bear is over. The effect of multiple cycles on the “rowing” portfolio is cumulatively compounding gains while the result for the “sailing” portfolio is recurring breakeven. The second cycle (using the same assumptions) drives the “rowing” portfolio from $107 to $85 and then to $114. The score after the third cycle: Mr. Market = $100 and your portfolio = $121. Three cycles of breakeven for the market still results in breakeven—you can’t make up for it with volume.

Of course, skeptics will respond that there’s often a difference between theoretical illustrations and empirical experience. Further, the S&P 500 Index has, at least at this point, increased 23% from the start of this secular bear in 2000. Yet the disproportionate impact of losses over gains is a formidable power.

As reflected in Figure 1, the S&P 500 Index started this secular bear market at 1469 and then took an early dive, ending 47% lower at 777 in October 2002. Five years later, the S&P 500 Index peaked at 1,565—up 101% from its low. By March 2009 the S&P 500 had sunk by 57% to 667. Now, four and a half years later, we are up 167% to 1,805. Cumulatively, the buy-and-hold portfolio (excluding dividends and transaction costs) is up 23% over the 14-year investment period.

For the alternative approach, let’s divide the percentage moves in half and apply them to your portfolio: -23.6%, +50.7%, -28.4%, and +83.5%. Your initial investment of $1,000 declined to $764 in less than two years. With half of the market’s gains, your portfolio climbed to $1,152 five years later. Then, applying just half of the subsequent market decline, your gain sank to a loss of $825. Ouch!… a gain yields to a loss. Note, however, that while the market found its bottom below its 2002 trough, your portfolio is nicely above its previous dip. For now, accept that consolation prize.

Figure 1. Half & Half vs. The Market



Then, with just half of the market’s gains over the past five years, your portfolio again advances to new highs. Over the secular bear cycle-to-date, the market is up 23%, compounding at a modest 1.5% annually. Yet your portfolio is up 51%, providing twice the compounded gain. With dividends and other income from your “rowing” portfolio, you have solid real (inflation-adjusted) returns.

Some people

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