Putting the Defense on the Field

Probably the best way to start to start this article is with the title – it’s time to put the entire defense on the field at this juncture.  In all but our aggressive model, I rotated a portion of our portfolios into bonds in late-January, the time has come to be even more defensive.

 

This is not a prediction of a coming market crash, but it is the action I’m taking in our clients’ portfolios in order to first, preserve capital as the shock-wave resulting from the coronavirus makes its way across the globe, through the economic system, company sales, income and profit & loss statements.

 

As I write this, the market is up right around +3% today, which at any “normal” time, would sound wonderful!  The problem is, it would need to gain around 7% more, just to get back above yesterday’s high!  And if one thing is for sure, people are terrified, as indicated by the CNN “Fear & Greed Index,” below.

 

1-FearGreed-Index Putting the Defense on the Field

The Fear/Greed index is normally a contrarian indicator.  In other words, when fear reaches extreme highs, it’s typically a good time to buy.  However, “A good time to buy, for who?”  If you’re a short-term trader, then this might be a great time to get into the market with the plan being to hold your investment for maybe a few weeks at most.  I’m not a short-term trader, so that’s not what I see when I look at this sentiment indicator.

 

Here’s one of my recent tweets (from yesterday), where I pointed out that it only took 14 trading days to wipe out 2 ½ years of market growth.  Even during the 2007-09 market crash, there was one time when the S&P500 fell by more than -7%.  It’s done that three times, just this past week!

 

2-Tweet Putting the Defense on the Field

 

In fact, there has never been a time in United States history that the market fell into a bear market faster than it did this past few weeks (a “Bear Market” is defined as a drop of -20% or more).  You can see below how 1896 is the 2nd-place winner, then The Great Depression, but even Black Monday (in 1987) takes home an honorable mention medal for this feat.

 

3-Fastest-Bear-in-History Putting the Defense on the Field

 

Speaking of The Great Depression, this next picture speaks a thousand words. What you’re looking at is the magnitude of the most recent drop in the stock market.  Back in 1929, the market bottomed 49 days from the peak.  The current -28% drop has been twice as fast.

 

4-Today-vs.-Great-Depression-1024x495 Putting the Defense on the Field

 

As my friends at Optuma (the research software I use for all my analysis and testing) pointed out, after bouncing to roughly the 50% retracement level of the initial decline, it rolled back over and didn’t find a bottom until 1932.

 

5-Today-vs.-Great-Depression-FULL Putting the Defense on the Field

 

I’m not saying that we’re going to experience a market crash similar to that of The Great Depression.  What I am saying is that I’ve taken measures this past month to “put the defense on the field” in order to protect against a catastrophic market crash.

 

I think this market will bottom out once I stop hearing people tell me that they “think this is the bottom.”  I’ll get emails, text messages, and private messages on twitter from investors saying, “I think this could be the bottom today.  What do you think?”

The answer:  “I have no idea… and neither do you.”

 

What I do know is that I have a rules-based process that takes all the emotion out of the investing decisions that I make for our clients.  The indicators I’ve built within my trend model have been tested over good markets, bad markets, and flat markets… and once risk levels reach a certain point where it’s no longer worth taking risk in the market, this is when we put the rest of the defense on the field and move into capital preservation mode.

 

Speaking of risk, there is a difference between a calculated risk and gambling.  Below, I highlighted times when I feel that “buying the dip” is a good, calculated risk, based on my personal time frame and the rules I’ve built within my trend model.  I also highlighted the times when I feel that buying was more “gambling” than a calculated risk.

 

 

6-Calculated-Risks-vs.-Gambling Putting the Defense on the Field

 

You might be thinking to yourself, “But wait, the last ‘gamble’ in late-2018/early-2019 doesn’t look like it was a gamble at all!”  And you’d be right – with hindsight at your advantage.  But here’s another, similar ‘gamble,’ below.  Would you buy this dip?

 

 

7-Would-you-buy-here Putting the Defense on the Field

 

 

If you said yes, then the next chart shows you where you bought, and how it worked out in the end.  In other words, you would’ve lost more than half your money over the course of the following 12+ months.

 

8-This-is-how-that-worked-out-for-you Putting the Defense on the Field

 

For my time frame, the market is in a downtrend at this juncture, until proven innocent.  Like Newton’s 1st Law of Motion, “An object in motion tends to stay in motion until acted upon by an opposing force.”  This past month, the coronavirus was apparently the opposing force needed to reverse the momentum behind the uptrend in the stock market – and man, was it a strong force.

 

I don’t use just one indicator when analyzing the markets.  Think of each indicator as a “clue,” and the aggregate of all the indicators as “evidence” that helps me determine if the market is guilty, or innocent – in a downtrend or an uptrend.

Right now:

 

  • The market is below its 10-month trendline (moving average)
  • Its 13-week and 34-week trendlines are both trending down
  • Its 50-day and 200-day trendlines are both pointing down
  • More than 20% of the stocks are trading below their 200-day trend
  • My proprietary ranking of asset classes has Bonds as #1 and Cash/Money Market ranked #2, and
  • The Point & Figure (PnF) ranking system that I use, which eliminates time and only compares the price of each asset class vs all the others in a “round robin tournament,” so to speak… it is also showing Bonds in the #1 ranking spot with Cash / Money Market ranked 2nd (see the table, below…)

 

9-PnF-DALI-Ranking Putting the Defense on the Field

 

If coronavirus fears are miraculously wiped away over the weekend and Newton’s “opposing force” manages to push trends back to levels where I feel that it’s worth risking money in stocks, then I’ll be buying back in, even if I have to pay higher prices!

 

However, unlike the 4th quarter of 2018 and 1st quarter of 2019, I don’t feel that we will see another, rare “V-shaped” bottom in the market.  Even if we’ve seen the worst of this crash already, I think that it’s going to take some time for the fallout to work through the system.

 

If the market does end up heading higher from here over the next several weeks (or months), then I’ll get back in the game and put our cash to work.  Meanwhile, considering the current environment, I think we’re better off with a bunch of gunpowder.  As a caveat, it should go without saying that my strategy isn’t perfect!  There have been many times (more times than not) when I’ve put the metaphorical defense on the field and a tornado never arrived!  I’m okay with that.  The alternative is losing -40%, -50%, or more, and I’m not okay with that.  There is no such thing as a perfect investment strategy.

 

So, I can’t reiterate more, I’m not predicting a catastrophic stock market crash.  I’m just preparing for it.

 

Till next time…

Adam

Categories: Adam Koos, CFP®, CMT®, Market Commentary

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