The Big Reason Not To Be Negative Here
In my humble opinion, one of the keys to success in the investing business is the ability to remain both objective and flexible. Early in my career, I would occasionally "fall in love" with my positions, largely due to the fact that those positions had proved successful. In short, I didn't want to "lose that lovin' feeling" by making a change.
However, I finally learned that the only constant in life and the stock market is indeed change. And since change can be hard, it is important to be open and ready when it is time to pull the trigger.
To be sure, these thoughts apply to the current stock market environment. As I'm sure you are aware, there are any number of reasons to worry about the state of the market. And yet, so far at least, the bulls have been able to keep on keepin' on in what appears to be an ongoing secular bull market cycle.
This is not to say that the ride has been smooth. In fact, 2018 has been anything but so far as volatility has found its way back into the game and algo-induced/fast-money freak-outs have become a regular occurrence. And to hear the bears tell it, this alone is reason enough to believe that the good times are about to end.
Asking Myself Some Tough Questions
And yet, I continue to believe that the current corrective phase will be resolved to the upside. But at the same time, I must admit that I've been asking myself some questions lately. Am I guilty of being stubborn here? Have I fallen in love with the gains from this bull run? Am I ignoring the threats from the headlines?
Given the fact that I'm asking these kind of questions, I believe the answer to all of the above is, no. And should my major market models turn red, I will indeed make a change.
But that is really the point. While everything isn't exactly peachy keen in indicator-land, there also isn't much of a case to be made for the bears here.
Reasons Not To Be Negative
For example, the Daily Advance/Decline Line recently hit a new high. The bottom line is this just doesn't happen at the beginning of bear markets. No, it's actually the opposite that tends to occur as the A/D lines (and other breadth indicators) tend to break down and begin to trend lower long BEFORE the indices start to roll over.
The same can be said for stock market momentum, which isn't half bad at this point in time. Oh, and don't look now fans, but the small-cap indices hit fresh all-time highs yesterday. Again, this type of stuff just doesn't happen when the bears are starting to grab control of the game.
Sure, there is a flipside to this coin. And I expect to get a bunch of emails citing examples of indicators that ARE breaking down and DO tend to lead the indices. In fact, my favorite "leading indicators" model recently gave a sell signal. So, as I said, everything isn't peachy keen here.
My Guiding Light
But then there is my "Desert Island Model." The model I would choose to employ if I was stranded on a desert island (or vacationing in a foreign land for a few weeks) and had to manage money with but one indicator. The good news is that this model remains positive and on a buy signal.
The current reading of the model's component indicators is 80%, which, as you might surmise, is a healthy score. Thanks to the computers at Ned Davis Research Group, tests show that since late 1979, the S&P 500 would have risen at an annualized rate of nearly 25% when this model reading was positive. So, there's that.
Conversely, when the model reading has been negative, the S&P has lost ground at a rate of more than -20% per year. Yikes.
And then there is the neutral zone, which, to me, is where managers tend to muck things up. This is where the outlook for stocks is cloudy and mistakes are easy to make. So, when the model has been neutral, I think it is interesting to note that the S&P has gained at a rate of almost 8% per annum. The important thing here is that the S&P 500 itself has gained 8.8% per year over the time frame.
My takeaway from this data is that from a longer-term perspective, it is usually best to stick with the bulls - especially when things are murky - unless the model is negative, of course.
Looking at the data over the last 10 years, which includes a decent chunk of the Credit Crisis Bear, I see that when the model was positive, stocks gained at a rate over 22% per year. When the model was negative, the S&P lost ground at an alarming -44% rate. And when the model was neutral, the market gained more than 13% per year.
Now consider that the buy-and-hold of the S&P 500 was 7% per year over this time frame and it becomes clear to me that the gameplan should be to give the bulls the benefit of any/all doubt - unless/until the model is negative.
The Bottom Line
Yes, there are lots of things to fret about at this point in time. But from my seat, this is a perfect example of the type of market environment where it is easy to muck things up by "doing too much." So, instead of trying to trade around all the headlines, the tweets, and the ensuing volatility, I think it is best to listen to the message of my big-picture models and give the bulls a chance.
Oh, and one more thing... Traditionally, managers have used the bond market as a way to cushion their portfolios during "sloppy" periods. But I think it is VERY important to recognize that although it's been a rough ride in the stock market in 2018, bonds are down year-to-date (the Barclays Aggregate Bond index is down -1.6% so far in 2018) and stocks are up about 2%. As such, sticking with the bulls appears to have been the right call. Well, so far at least.
And for me, this is the reason that one must remain open minded and flexible in order to survive years like this one. Best of luck to everyone out there.
HCR Awarded Top Honors in 2018 NAAIM Shark Tank Portfolio Strategy Competition
Each year, NAAIM (National Association of Active Investment Managers) hosts a competition to identify the best actively managed investment strategies. In April, HCR's Dave Moenning took home first place for his flagship risk management strategy.
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A Word About Managing Risk in the Stock Market
Thought For The Day:
Remember happiness doesn't depend upon who you are or what you have; it depends solely on what you think. -Dale Carnegie
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research
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At the time of publication, Mr. Moenning held long positions in the following securities mentioned: none - Note that positions may change at any time.
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 constitutes a solicitation to purchase or sell securities or any investment program.
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