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What Do I Do Now? ~ Guessing Causes Pain

Saturday, March 28, 2015

– by Sheila & Rich Jamison 

In the last two weeks, we’ve seen our GDP grow less than expected, new military combatants involved in the mid-east, Greece making the rest of the world nervous regularly, oil dropping, spiking and dropping again, an annual increase in corporate profits of only 2.9% (Bureau of Economic Analysis), some pretty good employment numbers, a poor durable goods report, consumer spending up, stronger housing, weaker manufacturing … etc., etc., etc. With all this we also saw the return of volatility.

Key Points

We’ve discussed volatility in several recent InSights. Two key rules are “keep emotion out of the equation” and “never predict.” Yet, it there is a deluge of material that makes this much harder to do than it shouldbe.

For example, a recent article pointed out we have had six years of virtually uninterrupted gains. It said,

“Stocks are up more than 200% over the last six years which is the best six-year run since the tech bubble.”

Further, it added that this was “well above the 85% historical average.”

(Our immediate retort could have been Yes, but look where we came from. Perhaps without the worst financial crisis since the great depression, there wouldn’t have been so much ‘extra’ room to run.)

The article looked at history for similar periods. Since 1931, it found there have been 54 prior periodswhere six year returns were greater than 200%.

Then it added, the average return over the next three years following these 54 periods was 9%. It contrasted that with an average historical three-year return of 38% for all rolling 3-year periods since 1931.

Other food for thought was that negative three-year returns after these up 200% periods occurred 35% of the time. Using all 3-year periods in that historic period, only 17% were negative.

The conclusions drawn: three-year returns following the strong runs were one quarter of the average three-year return and negative returns occurred twice as often.

On the Other Side

To the author’s credit, the next thing he looked at was that over the last ten years, stocks have gained115%. That is only 60% as much as the average of all historical ten-year returns. They averaged 192% returns. (This perspective addresses our earlier “look where we came from” criticism.)

We’re In a Box

So first he instills fear that the market has gone too far. Then he compounds that with the poor performance that often follows such periods. On the other hand, he points out that our historical performance since early 2005 lags the historical averages for 10-year periods.

What are we to believe? Are we too high? Are we too low? More important, what do we do now?

The author’s conclusion is “it probably makes more sense to adjust your expectations than to make radical changes to your portfolio.” What he omits telling us is what we should adjust them to.

Pain’s Source

We’re left with contradictory information and put in the position of having to make a decision. Worse yet, it is a decision that we probably didn’t know we “had” to make before hearing the author’s point of view. So we’re backed into a corner and “forced” into action with conflicting information on which to base that decision. We have to predict what will happen – which can’t be done … even with perfect information. What if we make the wrong decision? That raises emotion and worry and they cause pain.

The Antidote

Here’s where we’d like to offer that unemotional perspective. The data presented and the tone of the article could lead you to believe that a choice has to be made. That is, you’ve been sailing along feeling everything was okay as it stood. Now, you have to step in, evaluate imperfect or contradictory information, consciously pick a side and then act (even if that act is to do nothing). The choice is between take money out of the market because we had this good 6-year run and stay in the market because we’re behind on a 10-year basis.

Our Process

Let relative strength (RS) make this decision rather than engage in the fruitless game of forecasting. That’s the advantage of a tactical asset allocation strategy. It takes the stress of trying to make the right call off the table. If you already have a process to make these buy or sell calls, you don’t agonize over doing something every time a pundit says you should. Simply follow your process.

RS will not always be right. However, RS permits participation in long-term trends. And when it is wrong, it will not stay wrong. It sees the changes in the market. Those changes, once they reach a significant probability of being changes instead of volatility, change the signal.

Take Back Your Life

Perhaps more important, you can turn off the TV, ignore the pundits and go about doing whatever it is you really want to be doing with that time. The process is standing guard by watching the market.

A Key Distinction

Market timing is very different than tactical allocation. The former relies heavily on the luck of getting calls right and entails a large risk of devastating investment results. This is akin to the market pundits who show up on alternate days with alternate theories. The latter is pragmatic and disciplined. We believe it is likely to produce favorable investment results over time.

A Closing Caveat

In the world of investing, nobody or nothing is always right. Today, Warren Buffett is probably the world’smost revered investor. Recent headlines revealed he had a few obvious (and major) setbacks.

The RS strategy is NOT a guarantee. There may be times where all investments and strategies – including RS – are unfavorable and depreciate in value. But as we noted above, when RS is wrong, it doesn’t stay wrong.

If you’d like to discuss our process further, please give us a call to talk. We’ve always got time for you. And, by all means, please pass this InSights article along to anyone you feel could benefit from this information.

Sources:
Market Timing vs Global Tactical Allocation. The Money Managers. dorseywright.com. March 20, 2015.
Tactical Asset Allocation Using Relative Strength. John Lewis. Dorsey Wright Money Management. Pasadena, CA. March, 2012.
Where Do Stocks Go From Here?. Ritholtz Wealth Management. Theirrelevantinvestor.tumblr.com.. March 13, 2015.

The data above were taken from sources deemed reliable. However no guarantee can be made as to their completeness and accuracy.
Interpretations of the data, views and/or opinions expressed are those of the Jamison Financial Group based on market and economic conditions as of the date of publication and are subject to change. They do not necessarily reflect the opinions of any other individual, group or organization.
Nothing in the above is meant to be, nor should it be construed as, investment advice or recommendationsto buy or sell any security. Individual securities whenever mentioned are for illustrative purposes only and may not be relied upon as investment advice.
Tax and/or legal information contained herein is general in nature and for informational purposes only. It should not be relied upon as advice. Consult your tax professional or attorney regarding your unique situation.
All indices are unmanaged and are not illustrative of any particular investment. A direct investment cannot be made in any index.
The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
The NASDAQ Composite is a market-weighted index of all the over-the-counter common stocks traded on the NASDAQ system.
The S&P 500® is a market-capitalization-weighted index of common stocks.
Past performance is no guarantee of future results.

© 2015 Jamison Financial Group. Please feel free to distribute copies to individuals you feel may benefit from the information presented. Commercial use is prohibited.