Defensive strategies remain the best option for investors
Have you noticed that in the midst of this heated presidential campaign the candidates never talk about the financial markets? They occasionally make a reference or two about the economy but Wall Street and the major stock indices never get a mention. I suppose that is because it is difficult for them to take credit when the markets move up and they certainly don’t want to take the blame when the markets move down.
This week the indices have continued to struggle, even with a better than anticipated GDP number and with lower oil prices. There is no immediate end in sight to the downturn that began in October and investors need to remain defensive.
Below is a chart showing the S&P 500 over the past three years. I’ve highlighted a couple of aspects of the chart to better illustrate the current situation. First I added a red trendline to show the general slope of this bear market. This shows that since October 2007, the S&P 500 has lost about 300 points or about 20%. But if the same slope and duration persists, the damage will be more severe. From this point another 300 points lower would be an additional 24% loss.
I’ve highlighted the steepest drawdowns with blue arrows. One common question from clients is why we do not take more short positions during bear markets to try to make money on the downside. Notice the steepness and severity of these drawdowns. Often the bulk of the damage occurs in just three or four days. Our trading strategies are based on mathematical models. Experience has shown that if we apply too tight a trigger to the models, investors get whipsawed in and out of trades and it is difficult to capture gains.
Sometimes we do use short funds but it is usually part of a risk management strategy rather than an attempt to create profits. For example, one strategy has held a position in Prudent Bear fund (BEARX) for several months. That position is being used to hedge the risk of offsetting long positions.
The gold line on the top portion of the chart is a 50-day simple moving average (MA) of the S&P 500. Currently the index is holding right at that line. Since October, the only two months it has been above its 50-day MA were April and May. While we could see it bounce above that line again here, the market does not seem to have enough momentum to reverse the overall bear trend.
Finally, the bottom portion of the chart is a moving average convergence divergence (MACD) of the S&P 500. It is showing that the slight upward move of the past few weeks is already faltering. Any significant economic news could send the index plunging on another of those steep downward spikes.
For the near future, staying on the sidelines remains the safest place for investors.
F.S.
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