Weekly Update

Will the Robots Sidestep the Next Bear Market?

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Published April 21, 2017

TimingCube_cartoon042117The rise of robo-advisors over the past five years is not surprising given the nearly non-stop upward trajectory of stocks. Investors have been lulled into a state of complacency assuming the investment waters are always so calm and just riding the market indexes is a perfectly fine way to invest. The article below comes from an organization who, like us here at TimingCube, believes that robo-advisors and their buy-and-hold models are an accident waiting to happen. We buy insurance for our most prized assets. Why would we not buy insurance for our investment assets? Following a “tactical” investment approach as we do where you seek to sidestep damaging bearish market periods is like buying insurance for your investments. Herewith are some thoughts from the Delta Investment Group on the topic:

The popularity of low-fee index funds and the rise of the robo-advisor (computer based advisor) evolved from the traditional wealth management model. A buy-and-hold approach to investing is relatively simple and tax efficient. The strategy is easy to implement and manage. Many investors feel comfortable managing their own money with a buy-and-hold approach using low fee funds such as Vanguard or using the allocation advice of a simple robo-advisor Internet interface.

With the buy-and-hold approach, one of the few variables the investor can control is the fee level. Hence the increasing popularity of low-cost alternatives such as indexed funds and robo-advisor created exchange traded fund (ETF) portfolios.

What investors struggle to control are their emotions, especially during periods of euphoria and duress.

Two Major Problems with Buy-and-Hold

There are two significant problems with buy-and-hold. The first is it presumes an investor has a long-term investment horizon (20+ years). A buy-and-hold asset allocation plan takes no action to avoid an upcoming bear market. Let’s not forget that low-cost S&P 500 index funds lost 55% of their value in the last bear market and a 60/40 diversified stock/bond portfolio lost 41% of its value. The corrective action of buy-and-hold is to wait it out. Unfortunately, this can take years. Waiting to recover may not overlay well with life events including college tuition, home purchase, retirement, etc.

The second problem is investors have emotions. When we see our life savings cut in half, we can become scared that we are going to lose it all. When investors are unable to tolerate the discomfort of extreme paper loss, they often sell at the low. Conversely, when the market is in a strong bull trend, we tend to work up the courage to buy closer to the top than the bottom. For many, our emotions prevent us from being true to a long-term buy-and-hold approach.

The chart below shows the annualized returns of the average investor compared to stocks, bonds, REITs, a 60/40 equity/bond portfolio, a 40/60 equity bond portfolio, gold and inflation. Over the twenty year period from 1996 – 2015, the average investor under-performed all of these asset classes and inflation. It is likely emotions played a significant part in the under-performance of the average investor.

Chart 1: 20 Year Returns by Asset Class

20 Year Returns by Asset Class

The chart shows the average investor is not following a buy-and-hold plan either because of time or emotions or both. If they were on plan, their returns would fall in the range of bonds to stocks (i.e., 5.3% to 8.2% annually versus 2.1% realized).

What Do You Believe?

Do you believe the markets are perfectly efficient? Do you believe it is impossible to time the market? Do you believe stocks are equally attractive when the Price/Earnings (P/E) multiple of the market is 30 versus 10? Do you believe stocks are equally attractive when the economy is entering a recession versus emerging from a recession?

If your intuition says that owning stocks no matter what is probably not the optimal way to invest, we agree with you. So do the people who award the Nobel Prize. Robert Shiller won the prize in 2013 for showing that the price of stocks does matter and can be used to predict future stock action. History also agrees with you as we have never experienced a greater than -40% stock market drawdown in the past century without a simultaneous economic recession.

A Better Way

Even at a low fee and using diversified index securities, buy-and-hold is not working for the average investor. Potentially in the late innings of a multi-year bull run, adopting a buy-and-hold approach for the next eight years may prove to be a significant source of emotional and financial stress. Let TimingCube save you from that emotional and financial stress by following our easy-to-follow market signals. Conservative investors can go to cash on our Sell signals. Aggressive investors can seek to profit from the market’s declines by using our Sell signals to short the market. All investors are encouraged to use our Buy signals to invest fully in the market. A simple, effective method for protecting and growing your investment account.

Market Update

Investors breathed a sigh of relief Monday as markets opened after a weekend with no geopolitical skirmishes. Investors had been unnerved the prior week on increasingly tense dialogue between the U.S. and North Korea. Stocks popped +0.9% on the day. Struggles in the financial sector despite solid earnings from the big banks held in check any follow-through effort by the bulls Tuesday. Underwhelming results from Goldman Sachs (GS) further kept financial shares from moving higher leading to a -0.3% day for the broad market. Crude oil sold off hard Wednesday adding to the struggles of the financial sector as another positive report, this time from Morgan Stanley (MS), failed to fuel a rally. Nevertheless, stocks only gave back -0.2%. Happy words from Washington rekindled the bulls Thursday en route to a +0.8% rally. Reports that Republicans are getting closer to a unified position on health care reform along with encouraging words from Treasury Secretary Mnuchin on the prospects for tax reform provided the spark. Financial shares finally reacted positively to an earnings report with American Express and insurer Primerica both leaping on the heels of their announcements. Friday saw stocks again fail to capitalize on a possible rally effort with indexes dropping back -0.3% ahead of the weekend’s first round of elections in France. The election will narrow the field to two candidates. Investors are concerned that firebrand right-wing candidate Marine LePen will prevail, which is perceived to be a negative for stocks. Solid results from General Electric (GE) once more provided fodder that stocks have already priced in good results with the stock falling despite beating estimates.

For the week, the two strong up days pushed the S&P 500 (SPY) to a +0.89% gain allowing the index to recover some but not all of the prior week’s decline. The Nasdaq 100 (QQQ) continued its 2017 leadership pushing to a +1.66% gain. The small-cap Russell 2000 (IWM) reflected the positive week best of all with a +2.61% gain, reversing two weeks of losses, and coiling the index up for a big move ahead after over four months of flat, range-bound trading.

Warm wishes and until next week.