Login to your account

Lost your password?

State of the Markets: Busted: one of the greatest myths in investing

When the editor of Benzinga.com asks for something, I usually try to lend a hand whenever possible. Benzinga is probably the fastest growing stock-oriented site in the country, syndicates their content across the web, and partners with the big boys. But the bottom line is the BZ team works incredibly hard to do a quality job – and I’m honored to work with them.

So, when Joe Young sent me a note asking for a couple words on one of “the greatest myths in investing” I felt like I needed to respond. Never mind that I had been traveling all week and was nearly brain dead when I saw the email. I grabbed a Diet Coke, slammed it down and put on my thinking cap.

Within two minutes it hit me between the eyeballs. Then again, maybe it was the second Diet Coke kicking in. But in any event, I had the “myth” I wanted to bust.

Hogwash!

One of the greatest investing misnomers of all time is the notion that no one can “time the market,” so you shouldn’t even try. To which I’d like to emphatically reply, “Hogwash!”

Long-time readers know that I have addressed this topic a time or three in the past. However, this morning I’ve got some new charts to share, so this will hopefully be worth the while of the “dedicated dozen” who read my oftentimes meandering morning market missive every single day. (Oh, and on that note, I was informed this week that I have another dedicated daily reader – so thanks Chris, we’re up to a baker’s dozen now!)

The “time not timing” theme was perpetuated by the mutual fund industry during the secular bull market that ran from 1982 until spring 2000. The idea was completely self-serving as the purveyors of mutual funds wanted investors to put money in their funds and leave it there – forever. Why? To ensure a steadily increasing flow of fee revenue, of course!

The Problem Is…

To be fair, such a plan is a decent idea for those investors who have little time, knowledge, or interest in making their money work hard for them. Buy-and-hold is a fine approach – if (and only if) the investor sticks to it and doesn’t EVER waver – even when things get ugly.

But in reality, this isn’t the way the game works. You see, most investors are not level-headed financial pros with ice water running through their veins. No, they are human beings subject to emotional decision-making.

 

In the now-famous DALBAR study, the report showed that the average mutual fund investor wound up with a return of 5.02% per year over a 20-year period, while the S&P 500 made 9.22% over the same time frame. The point here is simple as the average investor tends to panic out when things get bad and return to the market when things look “safe” again. So, in essence, they wind up selling low and buying high. As another of the “dedicated dozen” likes to say, “This is not a desired result.”

Folks, We Have the Technology

But let me ask a question. How has that buy-and-hold strategy purported by the mutual fund industry worked out since the great secular bull ended? How did it feel to lose more than -50% not once, but twice in the ensuing 9 years?

The point is there are any number of simple methods to manage the major trends of the stock market that would have kept investors from watching their 401K’s turn into 201K’s during the 2000-02 technology bubble bear and the credit crisis bear of 2008.

Exhibit A in the “Golden Cross.” This is an incredibly simple indicator and just about anyone with an internet connection can stay up on this without shelling out a dime.

S&P – Daily

The game plan is to be in stocks when the 50-day moving average is above the 200-day moving average and be in cash when the 50-day is below the 200-day.

Using such a signal would have caused investors to move to cash in early 2008 and then back into stocks in mid-2009. And then more recently, as the chart above shows, the signal got investors into stocks in early 2012 when the S&P 500 was still well below 1400. (And for those keeping score at home, that was about 700 S&P points ago!)

This approach is not perfect by any means. However, it would have kept the vast majority of an investor’s 401K intact and allowed them to enjoy the vast majority of the stellar run seen over the last 6 years.

Below is a chart showing the key signals since the early 1960’s.

S&P 500 – Daily

The key though is the Golden Cross isn’t even a very good system! There are many, many approaches that produce far superior results. For example, a Trend and Breadth Confirm system sees the market gain at an annualized rate of +32.6% when positive and lose -23.4% when negative. Now we’re talking…

If I Was Stranded on a Desert Island With Only 1 Indicator…

Another example of a way to beat the pants off of buy-and-hold without doing much work is a system using the technical health of the 100 industry groups. This is a rather simple idea but does require some serious computing power.

The concept is to rate each and every industry based on its “technical health.” In short, you create a customized trend-identifier for each industry. Then, each week, you add up the number of industries with positive trends. When the majority of the industries are technically healthy, you stay invested in stocks. And when the majority are negative, you either go short or move to cash.

Below is a chart showing the buy and sell signals of this approach since 1980.

S&P 500 – Daily

What should jump out at you is the fact that this system gets the vast majority of the big moves right.

Looking at the historical data, the system would have been right 88% of the time since 1980 and produced compound returns of +18.2% per year (before fees, commissions, and taxes) versus +8.7% for the overall market when using a Long/Short approach and has been “right” 84.6% of the time using a Long/Cash approach.

And here’s the cool part… This system has only made 17 trades in 34 years. So, you don’t need to sit in front of a computer all day in order to stay on the right side of the really big, really important moves in the stock market.

The bottom line here is that I have been exposed to this specific system since the early 1990’s – and I’m a fan. In fact, if I was stranded on a desert island with only one stock market indicator, THIS is the one I’d have in my backpack.

Coming Soon To a Money Management Firm Near You

I like this concept so much that in the very near future, my firm will be launching a long-term risk management service designed to primarily keep investors on the right side of the really big, really important bull and bear markets. And while the program involves multiple strategies and multiple managers, the technical health of the industries system will be the primary engine of “The Risk Manager” service.

As far as other indicators are concerned, I could go on and on (and on). But the key here is to understand that the myth telling you not to manage risk in the stock market is just that, a myth.

– See more at: StateoftheMarkets.com

David Moenning is Chief Investment Officer at Heritage Capital Management, a Chicago-based registered investment advisory firm. Mr. Moenning began his investment career in 1980 and formed Heritage Capital in 1989. Dave’s firm focuses on “active management” and focuses on managing market risk on a daily basis. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Mr. Moenning is the 2013-14 President of NAAIM (National Association of Active Investment Managers) an organization dedicated to active management strategies. Follow Dave on Twitter at @StateDave.

Dave Moenning

David Moenning is Chief Investment Officer at Heritage Capital Management, a Chicago-based registered investment advisory firm. Mr. Moenning began his investment career in 1980 and formed Heritage Capital in 1989. Dave’s firm focuses on “active management” and focuses on managing market risk on a daily basis. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Mr. Moenning is the 2013-14 President of NAAIM (National Association of Active Investment Managers) an organization dedicated to active management strategies. Follow Dave on Twitter at @StateDave.