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.

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.

Hope and optimism that the economy may have bottomed were pushed to the front burner again, and all major indexes gained solidly to start the week out on a positive note.

Lowe’s better than expected first quarter results provided the fuel for the rally, which was followed by improved homebuilder confidence as well as an upgrade of the financial sector.

Our Trend Tracking Indexes (TTIs) moved higher as well and, as of yesterday, the domestic TTI has moved again within striking distance of a Buy signal:

Domestic TTI: -0.26%
International TTI: +4.20%
Hedge TTI: +1.97%

To avoid any potential whip-saw signal, I want to see a clear break above the trend line as far as the domestic TTI is concerned, just as I did with the international TTI a week ago.

I will keep you informed via future posts as to effective date of any buy signal that might materialize this week.

Saturday’s post “Buyer Beware of Risk control” elicited a number of reader comments. Here’s one I want to elaborate on:

In your post, “Buyer Beware Of Risk Control,” you highlighted the statement, “It does not really matter how much of a return you make during good times, what matters is how much you keep when the markets turn south.” I feel that is an oversimplification, and you may be inadvertently playing the same game as that of American Century management.

From 1976 to date, the S&P; 500 has provided a buy-and-hold return of 10%/year. If one is satisfied with a 10%/year return, then the (paper) losses associated with bear markets pale into insignificance. And if one compares the bear market negative with the bull market positive returns, then I submit that maybe just the inverse of your statement is more accurate.

First, the buy-and-hold crowd always looks in the rear view mirror and, with the benefit of hindsight, comes up with returns of what the S&P; 500 has done. Just to clarify, for the period from 1/2/1976 to 5/15/2009, the annual compounded rate of return was 7% and not 10% as quoted above.

Second, while that sounds great on the surface, it does not emphasize the pain and agony investors went through, including the 87 crash, to get to these numbers. Bear markets and huge portfolio draw downs along with their emotional impact on an investor’s psyche are not accurately reflected.

Third, the time period of evaluation is critical. For example, the S&P; 500 stood at 1,469 on 12/31/1999. It closed last Friday at 883. That’s a 40% loss over 9-1/2 years for those who simply bought and hold and matched the S&P;’s return. In other words, most investors have made no money during this century and only because they did not apply a sell stop discipline.

Stories like this abound. Recently an investor called and told me that his advisor made him 35% per year for 3 years in a row—before losing 80% in 2008. Put the pencil to these numbers and you realize that, after these tremendous gains, he has lost 50% of his principal. Tell me, where is the value in that? Making great returns is a useless endeavor, unless you can preserve them during market downturns.

Of course, you should strive for good returns during bull markets, but be aware that it is more important, to hang on to a large chunk of your gains when the trend reverses.

Translated into your personal life this means “it’s not how much money you earn, it’s what you keep that matters.”

While my main day-to-day focus is on the use of a disciplined investment strategy via trend tracking, it pays to look at the big picture every so often to see where we stand economically and to assess the effects of the financial bailouts.

Other bloggers are more qualified to talk on that subject, and I like to reference articles that mince no words, have no bias and simply want to tell it as it is. This week’s hat tip goes to Dr. Housing Bubble, who reviews some facts of the trillions of bailout money, which have been flushed down the ever growing sink hole.

Here are some snippets, but I encourage you to read the entire article so you can better view the enlightening charts and graphs:

Banks, take the blue pill. Public, please take the red pill. If I had to characterize the current economic environment, it would have to consist of two completely different sets of beliefs.

The foreclosure chart above tells us one thing. We are not helping the public. We are not solving the housing crisis. The notion that bailing out banks would somehow trickle down to the public is absurd. How many issues of systemic failure did we deal with? AIG? Fannie Mae and Freddie Mac? Lehman Brothers? The list goes on and on. With the AIG bailout, we used systemic failure as the premise to funnel money through the firm as a conduit to Wall Street firms like Goldman Sachs. Can’t allow them to lose a penny because that would be systemic.

And by the way, do you remember those estimates last year that the GSE bailout was actually going to give us a profit in the long run or at worst, cost us $25 billion?

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

While we don’t control any of these facts, it’s important to be aware of them for the simple reason that they control and influence market direction. This “disconnect” between Wall Street and Main Street has been obvious over the past few weeks as the rebound rally neglected facts in favor of hope.

Being disciplined with your investing endeavors is the only way to survive once Wall Street gets hit with a dose of reality, whenever that will be.

With the mother of all bears having mauled most portfolios in 2008, mutual fund companies are scrambling to come up with solutions to alleviate investor fear that nothing has been done to avoid a repeat performance.

American Century believes that their attention to risk control has been paying off:

About one-third of American Century’s 79 funds are in the top quarter of their categories for performance over the past year, according to investment researcher Morningstar Inc. For the past three years, more than one half of its funds were in the top quarter, and one of every four landed in the top 10%.

Last week American Century was named Best Large Mutual Fund Company at the 2009 Lipper Fund Awards. The prize is awarded to the fund firm top in “delivering consistent, risk-adjusted performance, relative to peers.”

That’s nice. They receive an award for “delivering consistent, risk-adjusted performance, relative to peers.” Every mutual fund known to man got slaughtered last year yet performance awards are being given out.

I have touched on this many times. If a mutual fund/ETF outperforms the typical S&P; 500 benchmark, this is a historic event and deserves praise. Never mind that the S&P; 500 lost over 38% in 2008. If a fund loses “only” 35%, they can boast that they have “outperformed” the index.

The fact that an investor in this fund is now sitting on mind boggling losses, which require him to have to gain 50% just to reach the break even point again, does not matter in the perverse world of Wall Street returns.

American Century still had several funds that trailed their benchmarks last year.

Chang added that while American Century stresses risk management, it also expects stock portfolios to be fully invested and not hold cash.

[My emphasis]

I am not sure why anyone would publish this information. The Ultra Fund lost 41.7% in 2008, yet it “is doing exactly what we told investors it would.” This has to be one of the most ignorant and selfish statements so far this year.

Take a look at the numbers. Ultra gained 21.8% in 2007 and lost 41.7% in 2008. A $100k investment in this fund would now be worth (at the end of 2008) only $71k, or a 29% loss.

It gets better. The Discovery fund lost 52.2% in 2008, but gained 31.5% in 2006 and 24.5% in 2007. On the surface, it seems that you should be ahead with those prior year gains, but you’re not. Your $100k actually shrank to a little over $78K.

I am not picking on American Century here; all fund companies will distribute similar information. My point, which I have been hammering on for over 20 years, is this:

It does not really matter how much of a return you make during good times, what matters is how much you keep when the markets turn south.

In other words, avoiding big losses is far more important than happily salivating over gains.

Hopefully, investors will have learned this lesson.

When you read stories like the above one above touting risk control, be aware that this has no effect on you as an investor. Mutual fund companies will always function as the ultimate buy-and-hold institutions no matter what wording is used. When the trend heads south again, it will up to you take action in order to avoid a repeat disaster of last year.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

A long overdue pullback handed the bulls the first loss in six weeks.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains below its trend line (red) by -1.10% thereby confirming the current bear market trend.



The international index has now broken above its long-term trend line by +1.94%, which triggered a Buy signal effective May 11. We are holding our positions subject to a trailing stop loss.