Monthly Outlook: May 2023
Markets continue to trend higher in April, although they faded a bit at month end. After a rough 2022, where the S&P500 lost 18.2%, the recovery of the past several months has been a welcomed reprieve. The S&P500 is “only” about 13% off its recent January 2022 peak and, more importantly, the trend is up, for now. Bonds, too, are trending higher this year after losing 13.1% in 2022. Interest rates, at least in the 2-year to 30-year range, have likely peaked for this cycle. Remember, lower rates mean higher bond prices. That said, the Fed may raise their 1-day Fed Funds rate a bit higher still and will probably keep them there for months until they trigger an economic recession. But again, that’s good for bond returns.
Although most markets are trending higher again, which suggests that investors are optimistic, the economic reports are increasingly bearish. Production, income, employment, sales, earnings, housing, confidence, and other reports strongly signal that a recession is coming, and probably soon. Its leaves us to ponder: Is this recent uptrend the real deal, or is it a false rally tucked between the bear market of 2022 and the one to come? Our answer is to focus on what we can know and invest with the price trend of each market. Actively manage your asset allocation and don’t guess.
Uptrends & Downtrends 80%/20%
We see ourselves as long-term investors, but we get to the long term one quarter at a time. We define the long-term price trend of each market (e.g., US Growth, INTL Value, Bonds, and so on) using primarily the 200-day moving average and a few other inputs. We have back-tested trends for multiple markets over many decades and we’ve repeated the tests a few times. We see, over and over, that almost all markets, over long periods of time, tend to trend higher about 80% of the time and down-trend the other 20% of the time. This bias toward uptrend is probably the basis for the popular “Buy & Hold” approach where an investor or advisor determines an allocation mix of bonds and global stocks, holds their nose, and holds on for dear life. They say, “You just have to take the 20% bad with the 80% good, right?” Wrong! We couldn’t disagree more. You see, history shows us that most uptrends are steady and long-term. But those downtrends tend to spike lower, and quickly, and they can really devastate a portfolio. They say markets go up like an escalator and down like an elevator. Investors need to manage the 20% (down) as much as they do the 80% (up).
Friends Don’t Let Friends Buy & Hold
We believe in many conventional portfolio management underpinnings: diversify, keep costs low, manage risk, and never lose big. We really don’t care if an investor chooses individual securities, funds, or index funds (our choice) to build a diversified portfolio. That’s one step to manage risk. But the biggest risk factor is one’s percentage allocation to any given market. If you own 20% in technology stocks, whether in individual stocks or a tech stock fund, and the NASDAQ goes down 30%, you’re going to lose a lot of money. A buy & hold strategy keeps investors fully invested all the time and does nothing to avoid “the big loss.” That’s the problem with it. Advisors who espouse this strategy, and it’s most of them by the way, try to convince you that you just have to accept the ups with the downs, don’t “time the market,” and trust that it will work out. That’s not good enough.
There are two analogies to buy & hold investing that I like. First, it’s like wearing one medium-weight fleece in Colorado year-round because the average temperature is 55˚. But you’ll freeze in winter when it’s -10˚ and swelter in summer when it hits 90˚. Second, it’s like setting your car’s cruise control at 62 mph to drive through Colorado’s mountains. Although that’s likely to be your average speed, it’s too fast through the hairpin turns, and not fast enough on the flats. You need to actively manage almost everything in life, and that includes actively managing your portfolio mix.
We use long-term price trends to actively manage asset allocation. Price trends are as factual as a thermometer or speedometer. They’re not a guess or prediction. They’re critical to managing the 20% of time when markets are down-trending to avoid the big loss. Whether the current market uptrends continue, or they roll over to a new downtrend, no one knows. But we know, and you should know, that by using “active allocation” and “trend following,” we will help grow and protect your wealth.