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The Difference Between “WHAT” and “WHEN”

Written by admin | Apr, 16, 2013

sp-500-4-std-dev-oversoldAs expected the market bounced rather sharply from its recent plunge which took the S&P 500 to 4-standard deviations below the 50-day moving average.   We had stated in previous missives and blogs that this would most likely be the case and that this would get the bulls all excited that somehow stocks were now the place to be again for the “long term”.

Honestly, this completely baffles me for several reasons.   1) Stocks, as an asset class, have been the worst performing asset class for the last decade.   Yet investors still chase them hoping to garner riches; 2) markets never move in one direction, however, the overall “trend” is much more important than daily variations of price; and 3) while valuations based on a trailing, reported earnings are essential to long term value investing – valuation models are horrible timing devices and you can lose a lot of money before being right.

I bring this up for several reasons but primarily because there has been a litany of articles published during the last week touting everything from the yield curve, earnings yields and forward valuations as a reason to jump back into stocks now.   Of course, the problem with all of these is that those measures, in a bear market, can wind up costing investors a LOT of money over time.

In recent missives we have dispelled the myths of the Equity Yield vs. Treasury Yields as an indicator of “value” in the markets.   Furthermore, low interest rates and a steep yield curve, when artificially manipulated is yet to be seen as being a reason to pay a premium in terms of multiples for stocks.

Let me be VERY clear.   At Streettalk Advisors, we are fundamental value investors.   Fundamental value, based on trailing, reported, earnings determines “WHAT” we buy.   However, the key to successful long term investing, and particularly when navigating highly volatile secular bear markets as the one we are in now and will continue to be in most likely for another decade, is the knowing the “WHEN” to buy.  

Therefore, once we have determined the “WHAT” to buy we must employ a set of tools to not only determine the “WHEN” to buy, but also, the “WHEN” to sell and the “WHEN” to just stay away.

For the sake of simplicity we will focus today only the S&P 500, but this same analysis holds true for any position, asset class or market.”

Individual investors do most of the damage to themselves by allowing emotions to override logical investing.  There have been many articles written about the rules of investing in the financial markets and the basics of them all center around 5 important concepts:

  1. Sell losing positions quickly
  2. Let winners continue to win – until they don’t any more.
  3. Never take on more risk than you can afford to lose.
  4. Always protect your capital investment by minimizing losses.
  5. Buy low and sell high.

Yet it is exactly these basic rules that investors continue to ignore and violate by buying into ideas like “dollar cost averaging”, “buy and hold investing”, etc.  

There is one major tenant that must always be honored if you are going to survive and prosper in investing over the long term – always protect your principal investment.  This does NOT mean you will never lose money when you are investing – you will.   If you are not willing to take losses in your portfolio – then you should not be investing to start with.   The unwillingness to take losses has led to more money being transferred out of individuals portfolios than at the point of a gun.   Losing money is part of the game…limiting how much you lose is what separates winners from losers.

sp500-macd-signal-081611The recent market debacle has NOT given rise to the opportunity to began aggressively investing into the markets.   All indications point to weaker markets ahead.    Does this mean that the markets will absolutely go lower from here  – no.  However, the “risk” of loss of investment capital at the current time is outweighed by the potential for return.

We use several different indicators, both long term and short term, to try and better determine the “WHEN” to invest.   It doesn’t always work.   However, here is a little known secret – nothing does.   This is also one of the biggest mistakes that individuals make when investing.   They buy into one strategy that is working (usually last year’s big winners) and then jump from that strategy to the next previously winning strategy when their returns suffer.   This is the epitome of what drives investors to “Buy High and Sell Low”.   

A disciplined investing strategy is one that requires, you guessed it, discipline.   That means that sometimes, even when it is not working, you have to stay with it (this is provided it is a sound investment strategy to begin with) as it will perform over the long term.  

The chart shows one of our signals over the last decade.  As you can see it generated a total of 28 signals over 11 years.   This obviously is not a “high turnover” or “high maintenance” tool and even a individual who was prone to “invest and forget” could have followed this simple indicator. 

By using a simple tool such as this one, the investor whould have stayed mostly out of trouble during market turmoil and captured, on average, about 80% of the upside movement in the market with only about 20% of the downside losses.    In other words, on a year over year basis he would have never beaten the market on the upside.   However, over the last decade he would be significantly ahead of the broader markets.  

This model is the very one that prompted us to raise cash and fixed income back in April of this year even as the markets were pushing higher.   We were chastised by media personalities for being “bearish” at the time.   However, our clients have suffered very little with the market downturn and are now in a position to capture the next advance when it occurs OR avoid the potentially recessionary downdraft that the economic numbers are telling us is coming.

At the current time we are still maintaining our hoard of cash and fixed income for the time being and keep equity exposure to a minimum.   

Here is the important point.   When this signal changes, whenever it changes, regardless of how we “feel” or what we “think” about the economy or markets as a whole (those are emotional biases) we will adjust holdings accordingly.   This will be the “WHEN” that we BUY the “WHAT” our fundamental values are telling us to.

Investors CAN do better.with their portfolios.   We remain in a “secular bear market”  – the same one which we have been writing about now for more than a decade.   Unfortunately, secular bear markets are long lasting, generally 15-18 years, so we have more work ahead of us.    The difference for most will be who survives this partcular market with capital left to invest at the beginning of the next secular bull market..   

Remember, finding the “WHAT” to invest in is easy.   Learning to find the “WHEN” to invest in the “WHAT” is what will make all of the differnce in your retirement portfolio.

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