Long term buy-and-hold strategies rely on up trending markets. Long term buy-low-sell-high strategies rely on volatility. That’s why behavioural finance analyst Ken Norquay recommends incorporating selling into your investment strategy.
Previously we looked at certain stock market mathematics and inferred the underlying stock market psychology based on that math. Let’s use the same statistical technique, ‘Do the math’, to compare various investment strategies. We’ll start by examining the short-term stock market performance so far in 2019.
The US market
A few months ago, in December 2018, the US stock market collapsed into its Boxing Day low when the S&P500 hit 2,347. There followed a sharp rally to 2,813. This is where I’d like to start doing the short-term math: there followed a 91-point decline. Then the short-term up trend continued to S&P500 2,860 on March 21; then a decline of 50 points; then the up trend continued to April 18, followed by a decline of 23 points. Since then, the up trend has continued and the zigzags are continuing to be small. What do all these boring statistics mean?
First of all, the market has been in a short-term up trend during the five months since Dec. 26, 2018, following the emotional slam-dunk earlier in December. Now focus your attention on the mini-down trends that occurred during this short-term rise. These ‘corrections’ have gotten smaller and smaller as the up trend progressed. Market technicians refer to those zigs and zags as volatility: for the first five months of 2019, there has been an uptrend and volatility has been declining. That’s what the math is showing us. Why is this interesting?
Volatility measures emotion in the market. We conclude that, as the short-term up trend progressed, investor excitement has declined.
Traders and technicians tell us that volatility is cyclical: there are alternating periods of high volatility and low volatility. When the current period of low volatility ends, we should expect a period of high volatility. Twice last year, short-term volatility increased dramatically: once in February and once in the last quarter. Each time the market dropped significantly. What should investors do in the face of this math?
Staring down volatility
Let us examine the financial markets from the point of view of trend and volatility. Let’s see if we can get a handle on market psychology and investment strategy by doing the math.
The US stock market touched a new all-time high in April, confirming the long-term up trend that began over ten years ago, in March 2009. In previous articles I have explained my bearish stance and my view that the orthodox stock market top occurred in January 2018 (S&P500 at 2,870). Since then, the S&P500 has risen at the rate of 2.2 per cent annually. Trend: Up at 2.2 per cent a year. Volatility: In February 2018, S&P500 dropped 11.7 per cent and in the last quarter of 2018, it dropped 20.4 per cent. And now it has made a marginal new high in April 2019.
Lots of volatility – little progress
The Canadian stock market is even more disappointing. Trend: From spring 2011 to now, the TSX Composite index has risen less than 2 per cent a year on average, for the 8-year period. Volatility: In 2011, the TSX dropped 24 per cent; in the nine months from April 2015 to January 2016 it dropped over 25 per cent and last year it dropped 16.9 per cent. And now it has made a marginal new high.
Observation #1: I have selected data that show the low long-term uptrend of the market, and the high volatility. Those who buy and hold received a rate of return based on the trend. Those whose financial plans involve buying low and selling high received a rate of return based on volatility.
The US and Canadian bond markets
For this volatility study I used bond prices, not yields. Remember that when a bond’s price goes up, its yield goes down and when its price goes down, its yield goes up. Trend: Bond prices peaked in July 2016 and have been in a down trend since then (i.e., interest rates have been in an up trend since then). Volatility: from July to December 2016, US long-term bond prices dropped 18.8 per cent; over the next 9 months, they rose 11 per cent; from September 2017 to November 2018, bond prices fell 13.8 per cent; over the past 5 months they rose 13.4 per cent.
The Canadian bond market reverses its trend in lock step with US bonds, but the volatility is often different. For example, since the July 2016 peak in both bond markets, Canadian bond prices are down only 3.3 per cent, whereas US bond prices are down 11.1 per cent.
Observation #2: Investors seldom think of the bond market as an arena for a ‘buy low—sell high’ strategy. Too bad! There is good opportunity here!
The US dollar vs. the basket of non-US currencies
Since 2014, the USD has traded in a range of between approximately 90 and 100, with only one swing in excess of 10 per cent. No trend and low volatility: this kind of stability is perfect for a currency that is the underlying basis of the world’s banking system.
The Canadian dollar vs. the US dollar
The last time the loonie was at par with the USD was 2013. There followed a dramatic down trend that took the Canadian dollar under 70 cents US in January 2016. This was followed by a sharp rebound to 80 cents US. Since then the loonie has traded in a trendless sideways drift between 72 and 80 cents US. The trend is neutral and volatility is 8 per cent to 10 per cent a year.
If the loonie continues in this ‘non-trend’, investors can increase their rates of return by increasing the foreign content of their portfolio when the loonie is in the 72 to 75 cent US range and decrease their foreign exposure when the Canadian dollar goes over 80 cents.
Oil up; energy stocks down
Energy prices are wonderful examples of volatility. The tricky part is the trend. In 2011 oil prices rose through $100 US and were still at $100 a barrel in 2014. No trend. But in those three years, there were price swings of $40, $35, $33, $35 again, $20 and $15: lots of volatility. Two years later oil had dropped under $30 a barrel: major down trend. High volatility.
From February 2016 to October 2018, it rose to around $76. In the next 3 months it dropped to $43. Then it rallied to its current level around $63. Statistically, since February 2016 the trend has been up; volatility is very high. Crude oil ETFs are good trading instruments for disciplined speculators. Ironically, though the trend of oil prices is up, the trend of energy stocks is down.
Gold and silver ETFs good for trading
The price of gold hit an all time high in 2011 at over $1,900/oz. The subsequent down trend took it to $1,045 US per ounce. Statistically, an uptrend started in December 2015. That 3 year, 4 month up trend produced several volatile swings: up 32 per cent until July 2016, down 18 per cent until December 2016, up 21 per cent to February 2018, down 12 per cent to September 2018, up 12 per cent until March 2019. Trend—up. Volatility—high.
Gold and silver exchange traded funds (ETFs) are good trading instruments for savvy market speculators. However, gold mining stocks have held the long-term down trend that began in 2011. Furthermore, the price of gold itself has not risen above its 2016 level. Although gold is in an up trend, if we take the 2016 rally out of the stats, gold’s trend is neutral, not at all rewarding for long-term buy-and-hold investors. However, the volatility is quite rewarding for traders.
It takes work to ‘buy-low-sell-high’
By now we can see my purpose in presenting all these boring statistics. Long term buy-and-hold strategies rely on up trending markets. Long term buy-low-sell-high strategies rely on volatility. That’s why I recommend incorporating selling into your financial planning.
There are a large number of ETFs that enable investors to participate in Canadian and US stock and bond markets, oil prices, and gold. These modern instruments, combined with discount brokerage services, allow us to efficiently buy low and sell high. The major obstacle is our own mind: are we really interested in improving our long term returns, or are we content to follow someone else’s lead?
For the more aggressive, there are ETFs that increase in price as the stock market, bonds, oil or gold go down in price: the so-called ‘bear’ ETFs. The same caveat applies: you need a well-thought-out investment plan. It takes work to buy-low-sell-high. If you don’t do the work, you are relying on luck, like the buy-and-hold crowd.
Ken Norquay, CMT, is the author of the book Beyond the Bull which discusses the impact of your personality on your long-term investments: behavioural finance.
This is an edited version of an article that was originally published for subscribers in the May 2019/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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