What happened in September and October provides us a pretty good instructive backdrop for this type of note.

Between 9/17/14 and 10/15/14  S &P 500 index was down 7.13% 

(source:  Worden Brothers TC2000 charts).

Additionally, if you read my last note, you knew I had moved some of our funds to cash.  This occurred primarily because I saw a technical breakdown in the energy sector and moved out of those positions.

Now I think it is critical here for you to understand that I don't wake up one morning loving cash specifically.  Cash in the portfolio is an event created when I believe that certain investments are no longer working or I am in a waiting mode.

Perhaps other people like to jump from one sector to another directly but I prefer to build cash.  I had a good friend on the New York Stock exchange who always told me that "cash is king and if you aren't sure what's happening around you don't worry about just sitting in cash for a bit".  I have found this to be true and it now, automatically, forces me into a thinking/questioning mode to dig deeper to figure out what messages the market might be delivering.

So what's the question?

And here is the first question I ask when I see some of my positions not working:  "Do I believe this is just a rotation from one sector to another or do I believe this is a larger more generalized downturn in the stock market?"

Look, there is a pretty large difference between a stock or a sector having a temporary problem and the entire market going to hell in a hand cart.  You need to know which is which.

In a rotation, sectors such as energy may have run into a speed bump.  In fact, you know from my earlier notes that such a rotation occurred earlier this year in March/April as money rotated from tech and into energy.  In a rotation the uptrend of the general market is likely to stay intact.

In a downturn, think 2008, even great fundamental stocks get thrown out the window.  At the bottom, certain companies are selling very cheaply on a fundamental basis and there seems to be no rhyme or reason to the sales.   Hopefully you are in cash long before the bottom and you can then shop for bargains.

 On average the stock market has a negative return approximately once every 4 years (Ibbotson Assoc).  The trick is you don't know when this negative will occur and sometimes these negative years come back to back (and sometimes "to back") so you always need to be prepared.

So which event was this?

So here is where the detective work begins.

Given the macro analysis I had been doing I must admit I was biased to this being a rotation.  While sluggish, the economy has continued to improve slightly.  Sure there could be rain that could fall on this scenario but I didn't see the components in place for this fundamental disaster. 

Secondly, I began to look at the technicals of other sectors and found a few that didn't exhibit the same negatives as others.

So which sectors do you look at?

Remember that when you are in the market you aren't just playing against the fundamentals, you are competing against other money managers.  Often times if you wait for the fundamentals to make themselves clear for certain companies, the opportunity to get in at a good price is sometimes gone.  To help you get ahead of the curve it is probably wise to build a mosaic rather than simply moving around randomly.

What's a mosaic?

A mosaic is simply a market picture developed from all of your data points and, yes, sometimes your intuition about what might be occurring.  It is certainly true that your mosaic can be wrong but it does overlay a framework that can be applied as you review the market.  Here is a critical point, don't confuse your mosaic for the market.  What I mean here is that many of us have to have conviction to make decisions and we believe we are right.  It gives us the strength to act.  At the same time, however, you must always remember that the market is never going to behave exactly as you predict and that the moment, the very instant , you discover that your mosaic doesn't fit you must admit that you are wrong and adjust.  Ego in these circumstances can be your worst enemy. 

So what was the mosaic  I developed?

Without getting into all the nitty gritty of the more quantitative analysis, here is how my thought process went:

 1. Energy production has been increased dramatically over the past year.  We have moved from an energy position characterized by import to one where we actually have begun to export.  At the same time, top line demand has not dramatically increased in many parts of the world so oil prices are beginning to come down.  In essence I believed that supply had just gotten temporarily ahead of demand.  Don't know how long it will last but it is the case for now.

2.  When fuel costs come down it creates a potential for people to have more discretionary income and up their consumer behavior.

3.  We are heading into the holiday season that happens to be characterized as one of the largest retail seasons of the year so the propensity to consume might be higher anyway.

So guess where this thinking leads me?  

I went looking at stocks that might be positively affected by consumer spending.

I also wanted to see how these stocks were behaving in the face of the price drops in some of the energy stocks I had vacated.

So this is some of what I discovered:

Between 9/17 and 10/15/14  

 (Worden Brothers TC2000)

S&P was down 7.13%

Occidental Petroleum down 13.16%

Devon Energy down 22.96%

Costco  down just 1.36%

Nike up 4.5%

Now I did not wait until the end of this period before moving into some retail but this breakdown does help me prove to myself that what was occurring was more of a rotation out of energy and trending toward other sectors.  Energy was obviously much weaker than the market as reflected against the SPY and some retailers were stronger than the market by the same measure.

Teachable moment?

I have taken you down the path of this most recent market hiccup in the hopes of providing you a view of how we think and act when such events occur.

I realize that there are many ways to manage money but this process fits me/us and perhaps you can find something to adapt to your own money management.

Or let us do it for you.  

All the best for a great Thanksgiving.