A Bear Market Or A Tarantula Market?

This is the point where sticking to investment process matters most.

Every fall we get a sort of tarantula migration through Walker, the little community near Prescott, AZ where I live. The header picture for this post is a tarantula that I took on our hike on Sunday. Every fall they come, they are visible for a while and then they're gone. There is a cycle to it and we know what it is give or take a week or so. There is also a cycle to when bear markets come, the biggest difference is we don't know exactly when they will come but we do know they occur every so often. It is a normal part of the market's process. As a client said to me the other day it's two or three steps forward and then one step back.

I remember a stat that I think came from John Hussman fairly early in the Financial Crisis that I think was something like the typical bull market gains 180% at the index level and then it gives about half of that gain back. I don't know if that was accurate but it creates a good context of understanding of how the bull/bear cycle works. The market goes up a lot for a few years and then gives a big chunk back in a shorter period of time and then it repeats. I don't think too many folks would dispute the repetitive nature of this cycle but nonetheless every time it happens there are investors who do panic and do self-destructive selling when they reach some sort of pain point.

The question is has a bear market actually started? I don't know, no one does, that is only knowable in hindsight. The odds that one has started have increased for quite a few technical reasons, the simplest of which is that the S&P 500 is below its 200 day moving average (DMA). I've said many times before that the index below its 200 DMA signals a problem with demand for equities. The problem may turn out to be serious or very temporary, right here right now there is no way to know...yet.

Since October 3rd the S&P 500 is down 8.5% which is a fast decline. I have long been a believer that fast declines have the tendency to be less serious than when the market rolls over slowly over a period of months. Ok, so this little nugget by itself is a positive but what if this is all part of a multi-month topping process. The S&P 500 is lower than where it opened on the first trading day of the year. A colleague from my time at Fisher Investments reminded me that nine months of negative returns is not a positive omen.

In May I bought AGFiQ U.S. Market Neutral Anti-Beta Fund (BTAL) for clients believing that the 2% rule had kicked in (an average of a 2% decline three months in a row). Either that was wrong (seemed to be the case during the summer) or it was a part of a big topping process which is still possibly the case, again there is no way know as we sit here today.

On Monday I bought the Cambria Tail Risk ETF (TAIL) for clients as the S&P 500 was looking at a second consecutive close below its 200 DMA which is consistent with my process. Once you choose an investment strategy you've got to stick with it or you risk making a serious mistake that could adversely impact your portfolio for a long time.

Laying out what you plan to do and then simply sticking to it makes for a much easier way to engage in markets. I knew (and blogged) that I would include BTAL whenever it was again time to take defensive action. I knew and blogged that I would then use some sort of inverse product which TAIL is for the most part and from here next steps could include another inverse product or even selling a holding or two all with the goal of avoiding the full brunt of any large declines that might come.

We're still not in large decline territory but the products I use for clients to try to blunt large declines are captured below;

While nothing can be infallible they are doing what I would hope they'd do. For anyone new I have been blogging about these names for months or in some cases years. Clients also own the Pacer TrendPilot Large Cap ETF (PTLC) which will switch to defense later this week but has been fully invested up to this point.

There's a cohort on FinTwit (financial Twitter) of younger advisors who've made comments that might be making fun of trend following strategies that use longer moving averages, someone made a comment about coming unglued when the index goes below its 274 DMA. I don't know if they were managing money in 2008 and their strategy could be to buy and hold on no matter what which is valid, after all after the next bear market a new high will come.

There is one thing I would push back on which is the implied premise in their tweets of completely selling out when some sort of breach happens. They're right, completely selling out is a terrible idea because it is a big bet with serious consequences if there is no bear market. In theory the bottom could have been today and the SPX could be a 3000 by year end. That's not a prediction, it is simply recognition that this time may not be the big one and the market could go higher. To sell out completely would be to miss out on that snapback and possibly pay a lot in taxes depending on the type of account.

Hopefully this post captures how little emotion there is to all of this, it is simply process and again, I have put protection on by buying defensive products. I did sell Square (SQ) earlier in the year after a huge gain in a short period thinking it would get punished in a protracted decline but that's been the only sale, clients are plenty long.

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