My Entire Reason For Being

One blogger captures the logic behind my investment strategy.

Of Dollars & Data had a blog post titled Easy in Theory, Difficult in Practice that did a great job capturing the anguish that builds and leads to panic selling at what invariably turns out to be the worst possible time, near the bottom of a large decline. The post breaks down the external emotional pressures that build until something has to give; the definition of capitulation.

The title refers to the idea that if you ask people now, while things are going fairly well (or at least not bad yet), they will say oh yes, we're due for a correction or of course the market will have ups and downs and so on. It is easy to realize that now but when things start rolling over it is difficult to not get fearful, it is difficult to remember your reasoned thoughts when things were going well and it is difficult to realize that this time is not actually different. As I have said more times than I can remember, the causes for large declines are different but the market manifestations are not. At some point the market will go down a lot, it will scare the hell out of a lot of people, then it will stop going down for maybe no reason at all and then it will go on to make a new high. The only variable is how long all that takes.

If you don't believe that will be the case next time then you should sell now an not buy equities again.

It is widely known/accepted that investor behaviors are the biggest impediment to investor success. If you have an adequate savings rate, a suitable asset allocation and don't repeat stupid behaviors then the market's average annual return will give you a great chance of at least being close to where you need to be. We all know the studies that show index funds outperform actively managed funds (often as a function of higher costs) but that the investors in both active and passive funds actual results lag far behind the funds' results due to behavioral issues like market timing and also life circumstances like needing to make untimely withdrawals.

The reason why I believe so staunchly in taking defensive action the way I do (based on trigger points and moving slowly) is to try to help clients avoid the frenzied panic that Of Dollars & Data described. Ideally with my strategy, client accounts will go down less than the market. If that objective is achieved it increases the chances that the client will not panic. And if the client does not panic then they are more likely to ride out the cycle more successfully for when the market invariably makes a new high. Again, if you don't believe the market will make a new high after the next bear market, then you should sell now.

As a reminder I take defensive action, just one trade or two to start, when the S&P 500 goes below its 200 day moving average, the yield curve inverts and/or the 2% rule is invoked (a 2% decline in the S&P 500 for three months in a row). I start small for two reasons, bear markets rollover slowly for several months giving plenty of time to get out and I could always be wrong.

Earlier in May, believing the 2% rule had been invoked, I bought AGFiQ US Market Neutral Anti-Beta (BTAL) because it has a negative correlation to the S&P 500 (it was up 74 basis points in Tuesday's decline) and thought it would be less of a drag than buying a straight inverse fund if I turn out to be wrong. I felt this was the best way to go since the 2% rule came into play before a 200 DMA breach which is unusual. For now it is too early to know whether buying BTAL was right or wrong but it was consistent with my strategy, I just stuck to my strategy with no emotion and if the purchase turns out to be wrong, that is a good thing, it would mean no bear market for now and to be clear, clients are plenty long, I didn't sell anything.

I often say you should choose, and then stick to, a strategy that you have a basis to believe offers a reasonable chance for success combined with allowing you to remain disciplined. I think that describes my relationship with my approach to a T. You should be able to say/do the exact same thing with whatever strategy you have chosen for yourself.

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