Not Getting It

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In regards to my recent post “More On Risk Control,” one reader had this to say:

With only a cursory review of your market timing/trend following investment approach, I find it to be quite conservative. If I remember correctly, some time early this year, your market timing index was waiting for a 20+% increase before getting back into the market. I took this snippet from the October 8th edition of the New York Times for your and your readers’ consideration. I felt the last sentence in the quotation below was most relevant for market timers.

H. Nejat Seyhun, a professor of finance at the Ross School of Business at the University of Michigan, put together a study in 2005 for Towneley Capital Management, where he tested the long-term damage that investors could do to their portfolios if they missed out on the small percentage of days when the stock market experienced big gains.

From 1963 to 2004, the index of American stocks he tested gained 10.84 percent annually in a geometric average, which avoided overstating the true performance. For people who missed the 90 biggest-gaining days in that period, however, the annual return fell to just 3.2 percent. Less than 1 percent of the trading days accounted for 96 percent of the market gains.

This fall, Javier Estrada, a professor of finance at IESE Business School in Barcelona, published a similar study in The Journal of Investing that looked at equity markets in 15 nations, including the United States. A portfolio belonging to an investor who missed the 10 best days over several decades across all of those markets would end up, on average, with about half the balance of someone who sat tight throughout.

[My emphasis]

This response is most typical for those deeply entrenched in buy-and-hold investing, which is also the most widely held view on Wall Street. The prime reason is so that the commission hungry armies of salesmen can always justify selling product to unsuspecting investors whether it makes sense in the current economic environment or not.

The most violent rebound rallies occur in bear markets more often than in bull markets. To state that missing the 10 best days will lead to inferior performance is simply not thinking straight.

The past year or so is a prime example, because it proves that you do not need to participate in every sharp rally, whether it happens on one day or over 6 weeks, to be ahead of most investors. By all measures, the recent 30% plus rebound of the March 9 lows qualifies as a dramatic rally in scope, yet we did not participate.

Because we avoided the big market drop last year by selling out on June 23, 2008, we have the luxury to wait until a new major trend develops before making a commitment again.

And if that means that we miss out on one of those best 10 days, it does not really matter. Because the S&P; 500 needs to rally 45% from yesterday’s close just to get back to the same price level it was when we sold on June 23, 2008. That’s a daunting task indeed and represents a figure that you’ll never hear quoted by the buy-and-hold crowd.

Our domestic Trend Tracking Index (TTI) is within striking distance of generating a new buy signal. If it materializes this week, it means that we’ll be buying in at far lower prices than we sold, but at a point that does not simply represent random bottom picking and guessing.

It represents a point in time, where a trend reversal appears to be occurring, which allows us the opportunity to get onboard again while at the same time our clearly defined exit strategy will get us out, in case we’re wrong.

Yes, as trend trackers we actually admit from time that we’re wrong, and that we may have to take a small loss in order to avoid a big one. There should be a lesson in that for the buy-and-hold crowd.

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Comments 6

  3. Ulli,

    Wow! Ulli I liked what you had to say today and you are so right. I also like to say in reference to what was said about missing those 10 best days for the buy & hopers and that is that they never say much if anything about what if one were to miss the 10 worst days, imagine that. I am a trend follower and plan to never participate in any long term downtrend other than with a hedge position if warranted or a simple short position with a bear ETF such as SH. Even if the SP500 were to rally that 45% to get back to even with your sell date, the buy and hoper would just start feeling comfortable again and repeat the same mistake all over again.

    T.M.

  4. Ulli,

    I recently attended a very high class charity benefit ballroom dance with a complete very popular big band. Lots of classy wealthy people in attendance. I noticed a neatly dressed man most likely in his early 50s going around from one table to another shaking hands and hugging the ladies, acting like he owned the place. He had a beautiful blonde lady a lot younger than him whom he was introducing to all the people at the tables he visited. He had a big metal cross hanging on a chain around his neck. At first I that he was a spiritural leader of some type. Then it dawned on me that he might be a “Money Mangler”. Later the master of ceremonies announced that this guy had just purchased a bunch of raffle tickets for some people and had reserved several tables for select people. The next day I saw an ad in the paper and sure enough he was a “money Mangler”. My point in all of this is that these guys as well as those who do studies of the market such as what you wrote about today is all aimed at the unsuspecting helpless, hopeless buy and hope crowd.

    T.M.

  5. Your concluding sentence is what enables me to sleep at night:

    Yes, as trend trackers we actually admit from time that we’re wrong, and that we may have to take a small loss in order to avoid a big one.

    Thanks for sticking to your guns.

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