Before I forget, here is last week’s BNN show.
A reader emailed me directly and asked me to give an honest appraisal on the pluses and minuses of using a more active approach such as we at ValueTrend do. This blog is an edited version of my response to his question.
What’s the difference?
ValueTrend’s approach is that of using technical analysis trading parameters combined with fundamental evaluation of stocks. A more traditional buy/hold portfolio tends to focus entirely on fundamentals. For clarity, many managers call themselves “active” – but their definition of “active” is to sell stock A and buy stock B—the decision being to always stay invested, and pick your stocks based entirely on fundamentals. Our approach is different. While we use fundamentals to clarify the earnings growth potential and financial stability / valuations of the underlying – we make our actual buy and sell decisions almost entirely on technical factors. To some lesser extent we do employ seasonal trends, and of course material fundamental changes will influence an early exit. But its 99% technical decisions when it comes to pulling the “buy” trigger, or punting the position by selling. Further, our approach is considerably more active than the “Sell A, Buy B” managers. Our time horizons on those swaps are typically shorter- AND- (more importantly) we make macro market decisions to reduce equity exposure or beta altogether. In a nutshell, we not only move our positions around frequently, but we also changeour exposure to the market itself according to our views.
On the one hand…
To start——there is nothing wrong with buy and hold— but you have to be able to tolerate high volatility. To me, trading technically is more about smoothing the bumps. It’s not about knocking it outta the park and getting big returns. For example, during the 2008-09 market selloff, a good technical trading approach made a big difference. It should be noted that the S&P500 actually peaked in November 2007, while the TSX 300 peaked May 2008 – but for simplicity, I will call both as peaking in May 2008. That’s because the S&P, while slightly lower in May 2008, did not begin its historic crash until after the TSX peak.
Technical analysis upside
The chart below illustrates the most basic long termed parameters that I look at when it comes to macro market timing decisions. It’s a monthly chart highlighting the 10 month (200 day) SMA in green. I’ve highlighted the 4 phases of the market based on peak/trough analysis and that moving average. Base, uptrend, top, downtrend. Simple. This strategy is the most basic, yet essential, of a technical approach to decision making. Own stocks when the market is making higher highs and higher lows, while trading over its 200 day SMA. Don’t own as much exposure to stocks when its making lower lows and lower highs and is trading below the SMA. When the market is transitioning between those major trends – adapt a trading strategy – or hold to see which way it breaks. Note how the market has been pretty violent since the 2000 tech bubble peak. I implore you to read my book Sideways to really get a handle on this strategy. It’s the essence of Technical analysis. All else, while useful, is secondary.
From May 2008-to March 2009 (peak to trough) the TSX 300 and S&P 500 were both down more than 50%. In the same period, our equity platform was down 17% peak to trough. We were back to break even by the first quarter of 2010!, while the S&P wasn’t break even until August 2013. In 2011, markets fell by 22% that summer. We fell 7% peak to trough, and recovered very quickly from that drawdown. This year we are up at all time new highs, while the market has fallen about 6% from their peak prices thus far. And so on. We have outperformed the markets via Technical Analysis, but not by killing it in the bullish years. Our “deviation” of returns is low. The market has much more variability. This lower deviation has afforded market beating long termed performance and better sleep, but it’s not perfect in every year. Ironically, a defensive approach using technical analysis is not about making great retunes in good years – its more about not losing so much in the bearish years! Win by not losing, so to speak.
Buy & hold –not so bad
If you really look at it, you would have done fine even if you invested at the peak in May 2008 , held through the 50% meltdown, and kept holding. It took 5 years–until 2013 –for the S&P to break even. It took 9 year- until March 2017 – to break even for the TSX. Despite that period of pain, today you would still be WAY up if you had just held the S&P 500 through the entire meltdown. So if you survived the heart attacks and anxiety episodes, you would be nicely ahead today. The TSX, well, not so much – the buy & hold guys lose that argument. Nonetheless – the S&P 500 is up some 90% (almost a double) since its late 2007 peak – and it is an actual double since its May 2008 peak. You can see that its really been a question of volatility more than anything.
Technical analysis – the trade-off
By using the tools I talk about on this blog, we have managed to outperform. But not linearly. This, despite the lower volatility that a technical approach affords. In fact, we had an underperforming year last year when the markets went parabolic. Yes, we still made positive returns, but we underperformed the index by about half!. That’s because some of my technical parameters measuring relative risk (aka Bear-o-meter readings) was high. Thus, we held cash through that final stretch of last year’s parabolic bull market. Not because of the trend, mind you – but because of other quantitative factors that I have discussed regularly on this blog (e.g. historically low volatility, concentrated breadth, historically benign sentiment readings, etc). These factors suggested that the parabolic move in the second half of 2017 was unsustainable – so we ducked for cover by holding about 35-40% cash. Over time, that risk-adverse stance using technical factors to measure risk has paid off (e.g. 2008, 2011, 2014). And yes, this year it is paying off again– we are back to outperforming, making new highs in a market that is underwater since January. But it hurts when it’s not working – even if that’s only temporary.
I’m pointing out that it’s not a perfect world when you use Technical Analysis to reduce risk—at least, it can be temporarily imperfect (!).
So again—I view the process of TA as not something that is guaranteed to beat the market — but more a process of sleeping well at night. Also, I would say that if the market has a big correction, and you need the capital for RRIF payments or an expense, it’s so much nicer to know that you have had much less downside when the poop hit the fan.
Any opposing views or comments to this blog? Love to hear them! Comment below!
Do you run various different portfolios ?
What is the cash % in those portfolios ?
Our equity platform just moved to 20% cash –the income platform is always 50% fixed income which is short termed bonds and an element of HISA (high interest savings account) units.
We raise more cash if the 200 day SMA is taken out AND the last low (2580) on the S&P 500 is taken out. We typically leg out in stages, if that does occur.
BTW– I misstated that our income platform is “always” 50/50 fixed/ equity–that is actually our “neutral” position for that particular platform. We actually move allocations around according to current yields. The objective for the income platform is to earn 3-4% yield overall. When rates are low–as they have been for the past few years, we actually emphasise dividend paying stocks more. But, assuming rates rise, we might place a bit more emphasis on short termed bonds and de-emphasis equities. The point I was trying to make is the our income platform is not subject to going more or less into cash based on market cycles–its allocation is based more on the cash flow (income) objectives. Hope that helps.