When the market begins to flirt with all time highs I get a little nervous. As good as it feels, one can’t help but wonder if market highs are to be appreciated or if they are only signaling the beginning of the end.
Any seasoned investor knows that good times are filled with tough decisions. For example, you could sell everything knowing that:
- “Markets don’t go to the moon.”
- “You can’t go broke taking a profit.”
- “At these valuations there is no way you can make any money going forward.”
I know, I know. I have heard all of this and thought most of it myself back in 1996. And then what happened? The market went up and up for 3 plus more years. With that in mind, I thought that this month I would share with you some interesting facts about market history and market behavior.
What I know:
At some point in time over the last 100 plus years ALL of the G-7 countries have experienced at least one period where stocks lost 75% of their value. That is not good. And, the mathematics of a 75% decline requires an investor to realize a 300% gain just to get back to even. How hard is that? It would mean that you would have to compound your investment return at 10% for 15 years just to get back to even. Not an easy thing to do.
Take a look below at the chart of pullbacks from high water marks on the S&P 500 since 1908. Drawdowns of 10%-20% are fairly frequent, with 30%- 40% drawdowns less so. The large 1920s bear market dominates the figure with a drawdown of over 80%.
I became convinced many years ago that I could not predict the market’s direction. I could, however, overlay a technical indicator called a moving average (averaging a number of days in the market to establish a reference point and trend line) to give me a clear picture of the overall trend of the market.
One of the most frequently used measures of trend in the technical analysis community is the 200-day simple moving average (SMA). In his 2008 book Stocks for the Long Run 5/E: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies, Jeremy Siegel investigates the use of the 200-day SMA in timing the Dow Jones Industrial Average (DJIA) from 1886 to 2006. His work leads to a conclusion that using trend analysis can improve the absolute and risk-adjusted returns over buying and holding the DJIA.
By using trend analysis I can monitor the portfolio models that I oversee at Argent. When trend lines are broken I can look statistically at the historical risk of each portfolio and make necessary adjustments. One study which covered the market between 1901 and 2008 determined that the S&P 500 becomes 69.6% more volatile when it is trading below its 10 month moving average. That fact alone prompts me to do what I can to minimize that volatility.