Wall Street often touts that one cannot effectively time the market – this is a good story for Wall Street who wants you to keep your money invested at all times so the fee structure stays intact; however, portfolio management, and more importantly the management of risk, is the key to long term investment success. Risk is only equal to the permanent impairment of capital caused when your investment decisions are wrong.
Hopefully, by now, most should have learned that markets do not travel in a straight line either up or down; but rather oscillate within a given range over time. That range can be upward trending as we saw in the 90’s (which was due to the long term fall in interest rates and inflation combined with rising valuations) or it can be a horizontal trend as we have witnessed over the last decade (due primarily to falling valuations and poor monetary policies). The reasons for the secular (long term trading ranges) markets can be found in previous missives and are important in understanding the importance of applying some form of risk management tool to your overall portfolio management methodology.
When we talk about risk management in a portfolio we are NOT talking about treating it like a light switch and being all in or all out of the market. Investing for the longer term is not a game of Texas Hold’em. What we advocate is more along the lines of treating the overall allocation of the portfolio like a rheostat and dialing up and down exposure to risk assets as the overall market environment dictates. This is the purpose of the STA Buy/Sell Indicator.
We have run this indicator back to the 1930’s and found that it has an extremely good track record of identifying market peaks and troughs. It will not top tick the market or pick up the exact bottom but that is not our goal. Our goal, like the rheostat, is to dial up exposure after market bottoms have been clearly identified and dial down exposure to risk assets once tops are in. According to recent evidence provided by this indicator the market has reached a top in this cycle after throwing off a “buy” signal around early September of 2010. This indicator also got you invested in the market just before the bottom in March of 2009 and out just before the peak in 2010. It also kept you mostly out of the market during the decline in 2008.
As with anything, there are times that the indicator performs less favorable particularly during a strong bull market advance but while it may have limited some small amount of performance on the upside the protection from the permanent destruction of capital more than offset what gains might have been missed. Remember, investing is not a competition to be won or lost – it is about the long term growth of capital to ensure that the purchasing power parity of your savings remains intact to offset inflation. Any declination of principal of a significant amount destroys the long term compounding effect of the principal…and just getting back to even is not an investment strategy to live by.
As with our recent economic indicators now all rolling over combined with our buy/sell indicator kicking off a “sell” signal we are recommending reducing exposure to equities and commodities and raising exposure to fixed income and cash for the summer months which tend to be statistically weak anyway.