This month I’m featuring an important research White Paper written by Burt White, LPL Financial’s Chief Investment Officer. I call it a “Coffee Cup” read, because you’ll want to settle in with a cup of joe and contemplate his foresight. Below are excerpts, and I recommend downloading the full PDF report for your convenience. -Rose

The Phase After the Road to Recovery

Burt White
Chief Investment Officer
LPL Financial

In late 2008, when the recession was at its peak, LPL Financial Research rolled out the Road to Recovery, our roadmap of how we thought the market and economy would find its bottom and begin to recover. That journey unfolded almost exactly as we outlined from 2008 through the beginning of 2010. However, the economy does not stay in a recovery phase forever. Eventually, a recovering economy and revived market needs to evolve to one that shifts from healing to growing, recovery to prosperity, and survivability to sustainability. In a sense, the economy has already shifted from recession to recovery; now it gives way to the next series of mile markers, which will guide it from recovery to growth. The Road to Recovery is behind us now and the market’s next phase marks a new part of the journey: the Transition to Sustainable Growth.

The Next Step: The Transition to Sustainable Growth

In the next stage of the journey from recession to recovery to growth, the market enters a period where the catalyst for growth will shift from stimulus-led to business- and consumer-led expansion. The three stages of the Transition to Sustainable Growth are below:

• Transition Stage 1: Committing to the Recovery(stage we have just entered)
  The market is unsure if this recovery is really sustainable. As this idea becomes accepted as reality, consumers and businesses become committed to the recovery and begin to spend to fuel future growth.
• Transition Stage 2: Preparing for Life Without Help
  With consumers and businesses having committed to growth, the central banks of major countries start to hint at undertaking and even begin the tightening cycle. Markets and the economy must come to grips with the notion of growth without being propped up by stimulus and accommodative policies.
• Transition Stage 3: The Market On Its Own Two Feet
  With the tightening cycle across the globe in full force, growth shifts entirely onto the backs of consumers and businesses.

Click on the image for a larger view

Investing During Transitions
Before diving into more details on the three stages of the Transition to Sustainable Growth, let’s focus on some key rules for investing during periods like this. There are nine rules for navigating a market in transition:

1) Take Bigger Bets in a Fewer Number of High Conviction Ideas: In a trendless market, there are fewer great ideas which will mean investors will have to concentrate on a smaller number of high conviction bets.

2) Establish Trading Ranges: A shifting market will experience multiple pullbacks, but be largely range bound. Therefore, the most successful strategy is to buy the dips and trim the rips meaning a more active re-balancing strategy is a way to success.

3) Benefit from Increased Volatility: When volatility spikes, so may opportunity.

4) Don’t Give it Away in Fixed Income: Don’t forget about the fixed income side of portfolios as the potential for rising rates could make risk-controlling bonds actually risky.

5) Don’t Forget the Simple Rules: Don’t fight the Fed. Listen to the market. Beware when the crowd gets too optimistic or pessimistic.

6) Use Alternative Strategies, Not Just Bonds, to Help Manage Risk: Once central banks begin to raise rates and bonds do not provide risk control anymore, investors should consider alternative strategies to help cushion the downside.

7) Invest in What You Know: 2010 is not the year to be a hero or to guess have a plan and follow it.

Manage Expectations: After last year, expectations are sky high. As the market transitions to fueling sustainable growth, market returns will likely be volatile and modest. Remember the famous quote by Oleg Vishnepolsky: when you are expected to exceed expectations, expect the unexpected.

For the full report, download the PDF:

theWhitepaper February 2010

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