2010May26 Market decline likely to continueMarket decline likely to continue
As of May 24th, the decline in the S&P500 is the fourth worst May in history. The “Flash Crash” was a surprise but can happen again. It activated our stop loss process to sell all of our ETF positions and hold cash where the proceeds remain.
In order to generate positive returns in a relative strength portfolio, discipline and patience are required. News and temporary issues can cause investors to lose their focus and abandon their discipline. As Zacks Investment Research put it:
"Even though the market no longer seems to care about mundane things like earnings and revenues when there are such exciting things like a debt crisis in the cradle of democracy, this has been a very good earnings season."
If the fundamentals are strong, there's often strong demand for the asset--and that's usually where the relative strength comes from. Lately, the demand we normally expect from positive earnings reports has been absent. Questions remain: “What is going on,” and “Why is cash the place to be?”
Relative strength drives the dynamic asset allocation that we are using instead of modern portfolio theory’s (MPT) use of averages from the past 30 years. The averages have no bearing on what is happening in today’s economy or markets.
Here is a review of what we have described as a primary part of our process.
4 Steps to Asset Allocation:
No investment process is right all the time. Many times this strategy matches perfectly to the prevailing market environment, sometimes not as well. What we have committed to is a process that we have back tested several different ways with more consistent positive outcomes than following modern portfolio theory. When the trends we have invested in reverse against us, we will not sit still and hope for recovery. If wrong, we do not want to be wrong for long.
Our process and discipline guided our sell decisions rather than relying on our opinion about the future. MPT assumes the future will eventually look like the past. But, which past is going to repeat? None of the four decades below were close to the average – the blue line in the center. The more history you include, the greater the problem. (Graphic from HS Dent).
Compare this to a weather report. If the weather report says a thunderstorm is coming, we don’t take the boat out. We secure it so it can ride out the storm, or we get it out of the water entirely.
Do the predicted thunderstorms always arrive? No. Weather reports, as we all know, are not perfect.
Are the tools we use to manage risk always perfect? Of course not. But we sleep better by paying attention to “stock market weather reports.” Sure beats “buy and hold” which has really come to mean “sit and take it.”
If we’re working on being smart while dealing with markets, discipline alone will not carry us to the finish line. It’s the whole package – knowledge, discipline, and patience – that are going to guide us successfully to our goal. “Buy and hold,” “buy on the dips,” “indexing” and “strategic asset allocation” work in a bull market. They do not work well in other environments.
No matter what market environment we are in, crashes can be just around the corner. Crashes do happen. When risk rises, cash is our haven of safety.
If you have questions or want an appointment, call the office. Any staff member can schedule a meeting or a phone appointment on our calendars.
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