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One Simple Rule that can Save Your Portfolio
10/5/2012 2:34:00 PM
By: Cabot Heritage Corporation
Stock Market Video
The One Simple Rule that can Save Your Portfolio during Market Meltdowns
Winds Blow Hard On High Hills
In Case You Missed It
In this week's Stock Market Video, I discuss the situation in the market, which is positive, but not exuberant. The major indexes have rebounded from last week's correction, but there's still a lot of anxiety in the air. I look at some chart patterns that can help to find a good buy point for strong stocks. Stocks discussed: Rackspace ( RAX ), PulteGroup ( PHM ) and Gap Inc. ( GPS ).
One Simple Rule …
I wrote last week that I would tell you how to take control of your portfolio when market conditions change. So this week, I'm jumping on the "one simple rule" bandwagon that seems to be sweeping the Net to give you an investing idea that can save your portfolio when things get stormy.
I know that this will seem like a radical idea, because investment advisors have been telling us for years that 1) you can't time the market, 2) it's not possible for an individual investor to beat the market (the Efficient Market Thesis) and 3) accordingly, a widely diversified buy-and-hold strategy is the only one that makes sense.
You should recognize this argument, because it's one that most financial advisors and virtually every mutual fund company stresses. "Have exposure to every sector (so if one sector goes down, another will go up). Don't mess with your allocations. Just keep throwing money in."
That's a lot to take on, but I'm only going to tackle one small corner of it today, and that's the idea that it's impossible to time the market.
To start, I have a question for you: If you thought the market was headed down, how long would it take you to clear your portfolio and go to cash?
Think about it. If you were convinced that stock markets were entering a bear phase, and you wanted to get out of your S&P 500 index funds, how long would that take you?
Personally, given my concentrated stock portfolio, I could probably liquidate all of my holdings in under five minutes, including the time it took me to log on to my online broker.
I know. I've done it.
One reason big fund managers say you can't time the market is that THEY can't liquidate their portfolios. In the first place, their investment guidelines require them to be heavily invested in the securities described in the fund's investment prospectus. And in the second place, even if they could go to cash, their enormous investment positions would require months to sell without incurring huge losses as their sales drove prices down.
So one big advantage that you have over big investment funds is that you can get out of the market any time you want. And you can do it almost instantly.
So here's the rule: Any time the S&P 500 Index drops below its 50-day moving average and the average turns down, you sell any S&P 500 index funds you own and go to cash. And you stay in cash until the Index rises above its 50-day moving average and that moving average is trending up.
When the S&P 500 Index (the most widely used proxy for the broad market) is headed up, you own it, gaining exposure to stocks. When the Index is headed down, you sell your broad equity exposure and go to cash.
On average, you may have to buy and sell your S&P index funds a few times per year. But if you do this, your gains can be substantial.
As an example, here's what it would have looked like if you had followed this one simple rule and exited your S&P index funds when stocks fell in 2008.
S&P 500 Index Chart for 2008 With 50-Day Moving Average
You would have begun the year in cash, and bought your S&P 500 index funds in mid-April when the Index topped its 50-day moving average and the average turned up. You would have sold again in June (at a profit). Even when the Index poked its head above its 50-day in August, the average didn't turn up, so you would have been out of the market for the entirety of its 2008 meltdown.
It's not on this chart, but you would have reentered the market in May 2009, and would have stayed in all year, not selling again until late January 2010.
In 2008, when the S&P 500 Index was going through a disastrous drop from 1,468 to 903 (a 38.5% haircut), you would have lost nothing. That's leaving out the potential small gain in April and May.
Cabot has worked for decades to perfect our market timing indicators. We have short-, medium- and long-term indicators that involve a mix of sector indexes, averages and new highs and lows.
These indicators work because they don't try to predict what the market is going to do. No one can do that consistently and accurately. Rather, they allow us to eliminate most of the noise in the market data and identify the actual trend of the market.
Using the one simple rule I've given you, you can do the same thing for the portion of your portfolio dedicated to the S&P 500.
If you have friends who got slaughtered during the bursting of the Housing Bubble and the subsequent market meltdown-or missed the profitable upmoves since-this would also have given you some interesting bragging rights when you were swapping investment stories.
Here's this week's Contrary Opinion Button. Remember, you can always view all of the buttons by clicking here.
Winds Blow Hard On High Hills
Tim's Comment: Just ask Tiger Woods, or Mark Sanford, or Elliott Spitzer, all of whom suffered widespread scorn when their "indiscretions" were publicized. Before their falls from grace, those men were on top of their respective worlds. And so it can be for the investor who stands on top of his own financial world thanks to wise investment choices, combined perhaps with a bull market and a certain amount of luck. When all seems perfect, that's the time to be on guard. The trip down can take less time than the trip up.
[Editor's Comment: Stock market profits are hard to come by and easy to lose. This button reiterates the warning that it's easy to get ahead of the house in Las Vegas, but few go home with the house's money in their pocket.]
In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.
Having discussed good stocks in a previous issue, Cabot Small-Cap Confidential editor Tom Garrity uses this one to talk about bad and ugly stocks and how to recognize them. Stock discussed: AuthenTec (AUTH) .
In Tuesday's CWA, Tim Lutts, who edits Cabot Stock of the Month , details why he doesn't worry about the big issues that get headlines, like Iranian nukes. Contrary thinking means looking out for the un-obvious. Stock discussed: Tesla ( TSLA ) .
Friday's issue of Cabot Wealth Advisory featured Roy Ward's story of how he and his colleagues developed the software that drives the stock picks in Bejamin Graham Value Letter. Stock discussed: Nu Skin Enterprises ( NUS ) .
Have a great weekend,
Editor of Cabot Wealth Advisory
and Cabot China & Emerging Markets Report