As we have discussed during the last few newsletters, August thru October are commonly thought of as the most volatile months of each calendar year. August of this year brought upside surprises, while September was a complete bore in terms of stock markets really doing anything. However, October surprised many and during the month erased all the gains of the S&P 500 for the year. Ten months or gains suddenly gone in less than 30 days.
Lately we have been discussing risk, specifically over the last three newsletters. In October, risk happened and much of it to the surprise of many investors. Our models have us tapering down risk in many of our portfolios over the last 2 months and while we were not fully protected, we did miss a lot of the downside which October brought to many investors.
As of Late.
Subscribers of our newsletters have often read my restatements of "markets lose money so much faster than they make it." October was a prime example of this principle in action. If we look back 8 months, we see February had a very similar decline but the other indexes (NASDAQ, Russell 2000 and MidCap 400) only moved down in tandem with the S&P 500. During October, we saw many of the leaders, stocks which had led the market higher this year, begin to fall well in advance of the month of October and the decline is shown below.
You may be wondering what caused stock indexes to drop approximately -10% to -15% over the last 30 days or so. As we have been somewhat direct about stating the case for risk moving higher into the markets, particularly during the August thru October "Seasonality", I will reiterate some of the many factors which have played into the causes of this decline.
Our global partners, both large and small are struggling greatly. Our own economy has already peaked during the 3Q and here in the 4Q markets are starting to realize that company sales figures as well as forward guidance, while not falling precipitously, are "less favorable" than in the past months and quarters. The pinch from short term interest rates has started to take it's toll on those that contemplate markets daily (and I don't mean in a good way). Housing sales continue to fall as well.
Our models direct our investing time and time again. For instance, our sectors model told us to sell our technology/electronics holdings in the final week of September. We did. Today the price of that holding we sold is now at least 15% cheaper than when we sold it.
Another model we have, told us to sell a large index holding, the Russell 2000 very early in October. We followed that model action and today the Russell 2000 index fund we sold is still more than 10% below the price it was the day we liquidated it.
Our models did NOT have us sell everything during this time. We have never had sell signals occur en mass during a very short time window so we did not "dodge" the whole downturn effects of markets in October. However we did manage to have our portfolios miss more than 50% of the downturn. This helped our portfolios only have losses in the -1.5% to -3% range instead of the -7%+ range which the broader market delivered to fully passive investors.
With all the U.S. indexes down rather sharply last month, some might wonder; "Did anything work well in the markets last month?" While defining "well" is a bit of a task we will not take on, there are some areas which did show some benefits versus the indexes.
Utilities stocks were healthy performers last month and they were up nicely while the broad indexes were down as shown above. We had purchased the utilities portfolio back a few months ago. Also, the U$Dollar continued it's multi-month march higher into October and was up last month nicely. We had purchased the U$Dollar back in very early May. Additionally, consumer staples stocks did well too during the turmoil of October.
Short term bonds did a smooth job in terms of performance last month and while long term government bonds tipped downward, it was a total of just under -1%.
The concept about our math/quantitative models is that if/when the math is wrong, it does not stay wrong for long. They are constantly updated with new information every day and if the data points within the models begin to change the layout of what the models are focused on, the models can and do change quickly.
The Long-Term View.
We all know the old saying about investing, "Past performance does not guarantee future results". But even in the midst of knowing this, people still look heavily at past performance. In this section, we want to underscore what the past performance is so that we don't forget the past and have elevated expectations of what future returns might be. (These thing do run in cycles).
Many years ago, I met with the fund manager of a fund which had averaged 20%/year for 20 years, an amazing accomplishment indeed. His name was Gary Lewis and while incredibly smart, Gary was also one humble man as well as an easy man to learn from.
The odd thing about Gary's performance was not long after he hit the 20%/yr in 20 years, Gary retired. Nonetheless, even with Gary retired, people were still hoping that his track record would continue! (Hoping is not an investment strategy.)
On the other hand, as we look back at the returns of the S&P 500 for the last 20 years, we do this with a casual eye toward what returns might possibly deliver for us in the future. Doing so is an important element of the planning perspective. Over the last 20 years, after adjusting for inflation, the average annual return for the S&P 500 barely delivered 3% per year. Even if we compound all the dividends, we still ended up shy of just less than 5% per year. How many people who actually have a financial game plan, planned or are planning using those historical returns?
My first thought here is, have a financial game plan! If you don' have one, think about this: Would you build a house without a set of blueprints? If you do have a plan, how recent is it and does it incorporate your current status? One of the foremost experts in the U.S. about financial planning says the "Number 1 Mistake of Financial Plans is, IRA and 401k beneficiaries not being up to date!" Also, if you have a plan, does it have realistic assumptions about rates of return AND have you looked at the same plan design with different rates of return assumptions? Be careful your assumptions are not too far afield of what the last 20 years has given market investors.
We remain watchful.
Capital Research Advisors, LLC,
4185 B Silver Peak Parkway,
Suwanee, GA 30024
800 -767- 5364
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Hoping an investment will work out is also called, "Chasing the Market".
Chasing the market is something we often find people doing. If someone does not have a process which they could write down and someone else follow that process and end up with highly similar results, then they might be kidding themselves as to whether they really have a process or not.
Sometimes people see a falling market and want to buy it as it comes back up. This is often referred to as a "dead cat bounce". It simply means that when it stops going down and starts up a little, it is not really going much higher - it has NOTHING to do with cats. It is a concept and an illustration. Another way to refer to a highly similar action of the markets is when people choose an investment which has dropped/is dropping hard, they want to buy that "fall" in hopes it is near it low price and will start rising soon. This is sometimes referred to as "Catching a Falling Knife". Obviously it is fraught with perils.
But in general, chasing the market refers to entering or exiting an investment with the intention of profiting from an occurring development or trend. The evolution of efficient market theory suggests that the financial markets are extremely efficient with new factors influencing price often integrated into valuations in real time. This is typically evident in the market’s continuous trading, often making chase-the-market strategies futile.
Chasing the market is a concept that is derived from standard investing motivation. Investors and traders chasing the market seek to invest in new developments and trends that can be profitable for their portfolio. Market trading mechanisms and the efficiency of the market make it challenging for investors using chase-the-market strategies to identify substantial gains. For these reasons, chasing the market is typically a futile endeavor unless investors have large amounts of capital for investment. This gives institutional investors an advantage as they trade with funds from large pooled portfolio investments.
Chasing-the-market strategies can be profitable for investors with large amounts of invest-able capital. Generally, chasing the market can be important when new developments and trends present profitable opportunities or new twists to an investor’s current holdings. While markets are generally considered to be efficient both in valuation and market trading mechanisms, following new developments in the markets overall is what keeps prices fluid and creates profit in both the short and long term. Waiting too long to chase trends that have already been well established and priced into valuations is where investors may find trouble. Investing based heavily on market chasing emotion rather than careful analysis can also be problematic and typically unprofitable.
We currently have holdings based on the following in the six models we use most;
Small Cap Index/Russell 2000 This has been sold and this model is 100% in money market.
S&P 500 Index
SMid Cap Growth Index This was sold in early October.
Electronics Sector Index This has been sold and is 100% in money market.
Real Estate Sector Index This was sold in early October..
Utilities - Our newest Position
Japan Nikkei 225 Index
Long U.S. Dollar
High Yield Bond Index Inverse
High Yield Bond Index
Long-Term U.S. Government Bond Index
Ultra Short Term Tax-Free Index
U. S. Government Long Term Bond Index