ACTIONABLE ADVICE FOR FINANCIAL ADVISORS: Newsletters and Commentaries Focused on Investment Strategy

Predictions

June 18th, 2013

by Jerry Wagner

of Flexible Plan Investments

Last Tuesday night was a special night. I was having some out of state friends that I had not seen for over a year meet my wife and me for dinner. I picked out an outstanding restaurant with a wide deck perched on the tip of one of Michigan’s gorgeous fresh water lakes. I got the last table available for the 6:30 p.m. seating.

The night arrived. It was one of those beautiful summer evenings that we cherish so here in the Great Lakes state. We walked in a little bit early to meet our guests. But the hostess immediately said, “Your party is already here.”

I quickly scanned the lakeside deck. Our friends were not in sight. Before I could ask “Why?”, we were led into the restaurant and then into the deepest, darkest back corner of its interior.

As we neared the table, our friends announced, “We heard a prediction that it might rain tonight, so we took a table inside instead.”

Now, the whole purpose of the evening was to see our friends. And, we had a delightful evening of conversation that led to our ultimately being the last to leave the establishment late that night.

But I have to admit, every time I turned a bit toward my left, I would catch a glimpse of the happy diners sitting lakeside and a rising moon painting the surface of the water with a rippling path that seemed aimed directly at our table within the bowels of the tavern. I was envious.

Predictions! I’ve railed against them many times in these pages. Study after study has suggested the limited accuracy of most of them (actually short-term weather has established one of the better track records – but is that really just because it is so often simply a continuation of the present trend?)

Few, if any of us, are right more often than we are wrong, and the farther predicted events are off in the future, the more dramatically the error rate soars. Yet the investment news shows and financial writers seem to think that it is their job to air everyone who has a guesstimate. While most every expert sounds like the last, with the very few outliers, the average investor viewer/reader is quickly rendered numb by the volume and variance of opinions.

It’s difficult to form an investment opinion based on all the noise. Even worse, one study out recently suggests it is pretty biased noise that we are forced to listen to every day.

Green, Hand, and Penn (2012) – from Pennsylvania State University, the University of North Carolina, and Florida State University – documented that bad news events were more widely disseminated after they were initially reported than were good news events. They cite the journalistic motto “if it bleeds, it leads” and the notoriety seeking competition between reporters as the reasons for this behavior.

An emphasis on the bad can be cautionary, and one should always look at the worst case in assessing the risk of an endeavor, but a focus on the bad makes it difficult in a bull rally to secure all the benefits. In fact, it can make it difficult to even get into stocks in the first place. There are always a host of factors weighing in favor of avoiding stocks or any other investment. And, of course, those who are still sitting on the sidelines are only too happy to voice them.

When I started my analysis more than two decades ago, there was always pressure to predict. I resisted, and choose most of the time to report – to try to pass on my perspective of where we are and what the major trends were.

While that remains my intent, a number of years ago I succumbed and added a commentary column, that you are reading, where I could occasionally expand on my observations and suggest a destination. I do so very cautiously and I try to do it not looking out to the long run but just a week at a time. Still I expect, like everyone else to be wrong at least as often as I am right and can only hope that describing the big picture with a short-term focus can keep us in on the right side for the big moves while being wrong on the small stuff.

Our strategies approach investment management in much the same way. We try to look ahead only to the short term (a day, a week, or at most a month at a time) and try to stay with the big trends. We don’t predict, just look at the evidence and go with what is most probable, realizing that there are no guarantees, and that nothing is perfect. In evaluating strategies, we look at the volatility and the drawdown (maximum loss incurred historically), as well as how they relate to each other, to place them in context for portfolio allocation.

Yes, I have been saying we were in a new bull rally phase since the end of last year. That’s my opinion, what the odds are suggesting, and what our tactical strategies are still signaling for the most part. But I didn’t catch the exact bottom last year – that meant I was wrong for weeks. And yes, since then stocks have reversed three times to the downside, but so far the declines have barely reached 5%.

Here’s what the big picture now looks like – but here’s also what the short term looked like going into today’s trading:

https://flexibleplan.com/hotline/The-Bespoke-Report-061413-2.jpg

Source: Bespoke Investment Group

That short-term top in the lower chart is around where I said the market was perfect – so much for predictions! But I have been saying that this is a dip where one could buy. Within that bigger picture above you can see that that is still what it appears to be.

Going into today, the short-term down trend was still intact, which means in my experience it is still a good time to buy the dips, if you want to join the longer term up trend. It appears that today, the market will close above the downward sloping trend line. This often signals an end to a short-term trend, and the rally could begin anew.

Of course, if you listened to all the news shows today, you heard them worrying about Federal Reserve Chairman Bernanke’s pronouncement coming up on Wednesday’s Fed day, as if it is going to settle everything. While it is always possible that this meeting will be the time when he changes the market’s direction, historically, since 1982, these Fed Days have been very bullish for the market. But as with every statistic – anything is really possible.

How well is your portfolio positioned to deal with the uncertainty? I’ve found that the best way is to have a large number of different dynamic, risk-managed strategies (8-10) in my portfolio to best weather the markets’ vicissitudes.

Sunday was Father’s Day. The day began cloudy and windy. The forecast was for thunderstorms. All weekend, we had planned on having the family over for dinner outside on the deck behind our home…

The lake behind us was sparkling as we ate dinner… outside on the deck – a perfect summer evening in Southeastern, Lower Michigan – not a cloud was in the sky!

All the best,

Jerry

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