Reasonably Thinking

Recap & Outlook

The market finished 2011 at 1258, which is relatively unchanged from the start of the year.  Meanwhile, gold finished the year at $1567, which is lower than its third quarter high, but still good for a 9.6% gain on the year.  The 10yr note finished at 1.87%.

A year ago, I published 11 Themes for 2011, which highlighted topics to look forward to during the year.  While I was incorrect or early on a few ideas (unemployment rate, municipalities), I was relatively on par with others (Europe’s mess, ascendancy of Kim Jong-un, US fiscal woes).  Reasonably Thinking, my thoughts for the upcoming quarters are:

• A continued focus on Europe.  I foresee four outcomes:
  1> Germany, like the UK, decides to fly solo and departs from the Euro.  Even though this may seem far-fetched, the German people refuse pay for the fiscal mess of others.
  2> Peripheral countries issue bonds that are convertible into their pre-euro currency.  Thus, investors who fund weaker countries undertake the risk that returns received are not euros.  Furthermore, this mechanism incentives countries to align their fiscal policies.
  3> The ECB prints more euros.  Even though Mario Draghi and the ECB have championed against this idea, over the course of 2012, the ECB may be pressured to reverse course.  Such a move by the ECB would likely be viewed as permanent, and the Euro-zone would suffer from inflation.
  4> The entire system collapses.  All bets are off.
• Keep an eye on the risk-off safety assets of US Treasuries and precious metals
• The economy, housing, and banks continue to be a mess

In 4Q, I increased my exposure to real assets by purchasing oil producers and services; I also exited a very profitable PHH short position.  For 1Q, I need to reshuffle some assets for tax purposes and risk factor allocations (see below).  Moreover, I still find real assets, particularly gold and timber, to be attractive.

Performance

Over the past ten quarters, Overall performance has remained a steady 3-6% annual return.  For the past two years (data that best represents a fully funded portfolio), Overall Performance was on par with the market.  Published trades in the ReasonablyThinking portfolio has underperformed both, with the delta between the two primarily attributable to the acquisition and appreciation of precious metals.  In other words, the lag in stocks and ETFs (blue line) has been made up for (green line) by the performance in gold and silver.  For more detail on the calculations, please see Performance 3Q11.

To normalize these graphs, consider that performance is based on a starting position of $10,000.  S&P returns include dividends.  Although my performance results prior to 2010 significantly overshadow market performance, the amount of transactions and dollars involved was unsubstantial to accurately portray as a fully funded portfolio.

Asset Management

In 4Q11, I deployed some cash toward commodities.  All other asset classes remain relatively unchanged.  Cash was my largest holding throughout 2011, and it will continue to be until asset prices fall or unique opportunities are captured.

In addition to viewing portfolio holdings from an asset perspective, I recently learned to view assets from a risk factor perspective.  This view is becoming more common among sovereign wealth funds and endowments.  With this view, what matters is not the asset of a particular position, but more importantly, what risks will the asset respond to.  This is my first attempt at this, and this methodology may evolve over subsequent quarters.

Appendix