Global markets are exhibiting a high degree of correlation, above 80% and that trend is expected to continue for several years into the future. As a result, the way most investors had invested in the past simply won’t work in the future. Here are the tools you will need to navigate the new normal in world markets.
In my last column (“Is It a Stock Market or a Market of Stocks?”, I outlined my arguments for why this trend in correlation has occurred—the present secular bear market, the rise of globalization, exchange traded funds, program trading, and the advent of the financial crisis. When everything goes up or down at the same time, I argued that stock picking and buy and hold strategies is not the way to go, if you still want to retire on more than your social security check.
Now, admittedly I’m talking my own book when I tell you that I have long ago shifted from holding stocks and mutual funds for years, regardless of what the market does. I have also given up allocating my portfolio between stocks, bonds, commodities, cash, etc. simply because that’s what some academician says I should do. What’s the point in keeping 20-30% of your assets in bonds if bond prices are going down month after month? The same logic applies to any asset class. I want to put money in assets that I believe will go up, not down in price.
I normally invest in exchange traded funds (index funds called ETFs) and theme approaches to the markets. I find that the risk in ETFs are far less and the performance almost equal to individuals stocks, especially when all stocks, sectors and asset classes move in tandem.
As an example, I might buy an emerging market fund because I believe the widely-accepted theme that over the next five to ten years those countries will exhibit faster economic growth than other areas of the world. I might also purchase a medical equipment sector ETF if I believed that area will see exceptional opportunities in satisfying the needs of elderly Americans. In theme investing it is more important to get the sector, country or asset class right, than it is to select a particular stock.
Beta, another name for risk, is also a much more important concept to me now. I try to buy securities that have less risk (beta) then the overall stock market when the markets are falling and the opposite (higher beta) when they are rising. A triple ‘A’ corporate bond index fund or a Treasury bond fund, for example, would be my choice in a declining stock market because they normally have less risk and the price of the fund would go down less or might even go up in a declining market. On the other hand, a high beta emerging market growth fund would be a more appropriate investment when markets are on fire. That type of fund would be expected to outperform the market because of its higher risk factors. My ‘sweet spot’ is to try and identify investments with lower beta than the market and at the same time out perform the markets.
Those readers who have been with me over the last few years also know that I do not believe in a buy and hold philosophy. My detractors (and there are many) claim that what I am doing can’t be done and yet I keep doing it. I sell when I believe the markets are at high-risk levels. I buy when I perceive markets are at low risk levels. Some call it market timing, I call it common sense.
It’s not perfect and it certainly requires a lot of work. I look at over a dozen variables including fundamental stock, sector and market values, interest rates and bond yields, momentum and technical indicators, sentiment, other psychological and behavioral variables, historical data and Monte Carlo Theory among others. I’ve also have 30 years on the job and experience counts for a lot in this business.
In the beginning of 2008, I began warning about the dangers in the markets. By the middle of the year, I was advising readers to move to cash and/or Treasury bonds. At about the same time, I warned that the S&P 500 Index would bottom at around 684. I was off by 14 points. Shortly thereafter, March, 2009, I advised investors to begin to dip their toes back in the market.
The point I want to make here is that it is possible to buy and sell, not day to day or month to month, but when the markets dictate the potential for sizable losses. I view losses above 10% as a major threat to my portfolios. I will and do take action above that threshold anything less than a 10% loss I consider to be the price we pay for investing in financial markets.
Active management takes a lot of time, too much time, in my opinion, if you already have a day job. Gone are the days when you could go home, flip on your computer and count your winnings. There are simply too many day and program traders, armed with mega-thousands in high tech equipment and software, that trade for a teeny (1/16th) or less of a stock price.
If you don’t think you can compete on that playing field then find someone to manage your money for you, but make sure that person is spending 95% of their time looking at your investments. In today’s financial services sector, most advisors are passive managers, who buy and hold, practice rigid diversification and asset allocation schemes and spend most of their time marketing for new clients. That won’t cut it in today’s new normal.