It is said that those who ignore history are doomed to repeat it. To be accurate, it was George Santayana (a Spanish philosopher who lived from 1863 - 1952) who actually said, "Those who cannot remember the past are condemned to repeat it."
The point is that anyone who came into the stock market game over the past five years probably has a pretty rosy view of the experience. But, almost everyone else who has been invested in equities for the past fifteen years or so probably has an entirely different view of the market's "history."
Regardless of your personal history with the game, the key question after five-plus years of a bull run is pretty simple: Gee, this has been fun - But are you ready for the next bear market?
Why Worry Now?
Sure, stocks are doing well right now. And it's been one heck of a ride lately. The S&P 500 closed Thursday just a whisker off its all-time high. The Dow Jones Industrial Average and Midcap 400 indices both wandered into the Promised Land on Thursday as well. However, given that this bull market is now getting very long in the tooth, now might be an excellent time to make sure you've got a plan in place to try and avoid the beatings investors took in 2000-02 and 2008-09.
Think about that for a moment. And be honest. Do you have a plan for when to do what the next time the bears come out of hibernation?
Everybody in the game now knows that there are all kinds of tools such as inverse ETFs (for example SH, SDS, and SPXU) that are designed to profit from severe market declines. But do you know exactly when or how you will get those synthetic short positions put on? Do you have a signal to tell you when it is time to head to the sidelines for a while?
To clarify, I'm not suggesting that you run out and start putting some hedges on your long positions. Although no one would blame you if the thought of selling some covered calls, raising a little cash, or cutting back on the beta has crossed your mind of late.
No, the question of the day is, do you have a plan for exactly what you will do when this bull eventually morphs into a bear?
Getting the Big Moves Right
Spoiler alert to long-time readers: I'm climbing up on the soap box again.
To be sure, the stock market game can be incredibly difficult. For example, what on earth does the Japanese Yen have to do with the price of tea in China, or more appropriately for our discussion, the price of U.S. stocks? The answer is, a lot. You see, the Yen-Carry Trade continues to be a major deal in Ms. Market's game these days. But that's a story for another time.
The point is that there is a mountain of issues/data to stay on top of if you want to truly understand the stock market's movements on a day-to-day basis. But the good news is you don't need to keep up on all the minutiae in order to be successful. No, you just have to have a plan to get the really big, really important moves right.
Wanna make the stock market game uber-simple and get REALLY rich over the next 20 years? Take a look at the chart below and see if the road to riches doesn't leap off the screen at you.
S&P 500 Monthly 1994-2014
Over the past 20 years, investors would have made a pretty penny staying invested in the stock market. In fact, from 6/1/1994 through yesterday 4/3/2014, a buy-and-hope investor buying the S&P 500 cash index would have made +325.14 percent. Not bad. Not bad at all.
Granted, the ride would have been gut-wrenching. But, if you were busy with the job, kids, soccer, little league, vacations, etc. and simply forgot about the silly stock market, things would have worked out all right.
Bear Markets Suck!
Let's be honest though, bear markets are no fun. Watching your account invested in the S&P 500 drop -46 percent as the tech bubble burst in 200-02 stunk. And then after spending 5 years getting back to where you were in 2000, the -57 percent loss that accompanied the credit crisis bear market probably felt like a kick in the stomach.
But hey, if you stuck with it (did you? did you really?) things turned out okay. Again, a return of +325 percent is nothing to shake a stick at, right?
Math Can Be Your Friend
As you can probably surmise by now, there is a better way. Instead of sitting there and watching your account get mauled by the bears, why not do something (ANYTHING!) about it?
What do you suppose would happen if we attempted to capture 70 percent of the bull market gains and avoid one-half of the bear market losses? The answer is pretty cool. That +325 percent gain turns into +450.47 percent. And if my trusty desk calculator is correct, that's a 39 percent improvement over the buy-and-hope approach.
Granted, this is a VERY simplistic concept and the calculations don't take into account commissions or interest earned on cash. However, the point is you CAN do better if you have a plan of attack.
To further make my point, let's take that this idea one step farther. Let's say you can capture only 70% of the bull market period gains, but found a way to only lose 10 percent of what the market lost during bear markets. Ready? Believe it or not, the gain over the past twenty years improves to +873 percent, which is 2.7 times more than the buy-and-hope approach.
Thus, it would appear that the concept of avoiding losses has merit, eh?
Okay, now let's go crazy. Let's say you still can't find a way to capture any more than 70% of the bull market's gains, but you also found a way to make a little money on the big, bad, bear market declines. Let's assume the bear market takes you by surprise and things get nasty quickly. But then you find your bearings and buy one of those inverse ETFs that create an effective short position. Thus, when the market goes down, you actually make money.
Let's say that you find a way to profit on 30 percent of the bear market decline. For example, instead of losing -46.28 percent in the 2000-02 bear market, you actually made +13.8 percent.
Now, instead of a gain of +325 percent that the market offered since 6/1/94 or the +872 percent one would have made by capturing 70 percent of the upside and just 10 percent of the downside, you would have made +1,342 percent. Again, if the calculator is correct, that's more than 4X what the market did on its own. Hmmm... Now we're talking!
Yes, this is overly simplistic. No, achieving big returns is not easy. But here's the key... the ONLY way to achieve returns that are better than buy-and-hope is to have a plan. So next week, we'll explore a couple of ideas.
Positions in stocks mentioned: none
The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program.
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