Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

3rd Quarter | 2021

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

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By Peter Mauthe

Two weeks ago, I wrote about behavioral finance and how investors are often their own biggest barriers to investing success. The market action since February 19 has presented us with the perfect stage to see these common investing behaviors play out.

Let’s start by looking at where we were eight trading days ago. On February 19, the S&P 500 was at an all-time high having risen more than 5% (on a total-return basis) for the year. In addition, at that time government bonds were up more than 7%, gold was up more than 5%, and high-yield bonds were up 0.7% for the year. Everything was seemingly wonderful for investors.

Then, the coronavirus scare took investors by surprise. As of this writing, there have been 89,850 cases reported, 3,069 deaths, and 45,636 recoveries, according to the www.worldometers.info website.

Investors often forget that markets are most vulnerable to a sharp sell-off when they are at or near all-time highs. This is when optimism is at its highest and fear and volatility are at very low levels. Therefore, when, not if, a catalyst bursts that bubble of optimism, the markets adjust quickly to try to factor in the bad news. As seen in the following 12-year graph created by Michael Batnick, the coronavirus is only the latest “bad-news catalyst” among many in recent years.

In the seven trading days following the high in stocks, the S&P 500 Index declined approximately 12%. Last week alone, the Index declined more than 11%. Since 1987, there have been eight other occasions when a decline of this magnitude or greater occurred over five trading days: October 1987, April 2000, July 2002, October 2008, November 2008, February 2009, August 2011, and August 2015.

With statistics like that, it’s easy to see why an investor might start to panic. But is that panic really necessary?

Of these eight occurrences, only the April 2000 instance was at the beginning of a major decline. The rest were at or near the end of the market decline that preceded the sharply lower five-day period.

Of course, past occurrences can’t predict what will happen in this instance. But let’s take a look at what else was going on in the market while stocks were declining 12% from the high on February 19 to the close last Friday (February 28): Government bonds rose over 6%, gold rose nearly 3%, and high-yield bonds declined a bit over 2%.

Why is this important to note? Because it once again shows how having a portfolio that is allocated among different asset classes can make market times like these less scary. At Flexible Plan Investments, our core strategies include all three asset classes (stocks, bonds, and alternatives) and they are actively managed for both risk and opportunity. It is for that reason that we strongly suggest that at least 65% of a strategically diversified portfolio be in core strategies.

Don’t let fear drive your investment decisions

Of course, not everyone has the comfort of knowing their portfolio is strategically diversified, and as the selling progressed last week, some investors got increasingly nervous. This may have caused many to make the bad decision to sell when the pain reached a crescendo on Friday.

The following five-year daily-basis graph shows the S&P 500 and NASDAQ 100 Indexes over the volatility index (VIX, also known as the “fear index”). During the last five years, every time the fear index has spiked above 30, it has indicated the market was close to its correction low. Such spikes tend to happen when investors are fearful and making emotional—and often bad—investment decisions. In our nearly 40 years of experience in managing people’s money, we have seen many investors make the mistake of selling low and buying high. It is not hard to see that the correction underway now may be near its end. If so, then Friday would have been a good day to be buying, not selling, as many investors did or wanted to do.

Selling should be done when volatility is low, indicating there are ample buyers in the market that are generally moving prices higher. To buy when fear is high and sell when fear is low requires an investor to act in a way that is contrary to the mood of the market—which can be difficult. To avoid emotional mistakes, Flexible Plan develops and uses rules-based strategies that drive logical, objective decision-making with no emotional interference.

Let’s look at what is making investors so fearful. The fear is not of catching the coronavirus—it is that, in the attempt to contain the virus without the aid of a vaccine, nations and companies are restricting manufacturing and travel. If such restrictions get severe enough, and last long enough, economic growth could be reduced on a global level. The concern is that this reduction could cause a recession—which would be bad for stocks.

While this is true, any recession caused by fears of the virus will likely be short-lived. Many research teams are working to develop an effective vaccine for the virus. And once a vaccine can be manufactured in sufficient quantities, manufacturing and travel restrictions will be lifted and the world economy will likely pick up fairly quickly. It is also likely that any slowdown in the world economy will be followed by a stronger-than-normal economy due to pent-up demand caused by the restrictions.

Why emotional investing could cost you opportunity

Emotional, news-based corrections may interrupt a long-term trend, but they don’t usually change its direction. The following graph shows one way of looking at the recent five-year trend in stocks, represented here by the S&P 500. The lower boundary of the trend channel is represented by A and the upper boundary is represented by B. These boundaries are indicative only. They represent where rational buyers and sellers have been driving prices over the time represented by the graph.

When prices have exceeded the boundaries (arrows point to selling instances), it identifies when buyers and sellers have gotten emotional and overenthusiastic, at least on a technical-analysis basis. Times when investors act emotionally tend to be very opportune for investors who use rules-based approaches like those Flexible Plan uses, have a cool head, and recognize the opportunities when they arise.

Along the bottom of the S&P 500 graph, the weekly volume is plotted. Note the large spike in volume at the two 2018 lows and the low of last week. This may be another sign of investor capitulation (throwing in the towel at the lows—a bad investor decision), setting the stage for the next advance.

The majority of the 2015 drop to the lower boundary took only six trading days. Much of the 2016 drop happened in 10 trading days, and a large part of the fourth-quarter 2018 drop happened in 14 days. If we have seen the intraday low in the correction from the 2020 high, that drop took only seven trading days.

To put this another way, the long-term trend illustrated above is the market tide and the short-term movements up and down within the channel represent market waves. From a rules perspective, when building strategies and portfolios, statistically, tides can be reliably identified and rules developed to both manage the risks they exhibit and exploit the opportunities they provide. Short-term wave-type movements tend to be noise and much harder to exploit.

Build a portfolio that lets you ignore the “noise”

At Flexible Plan, we have designed strategies that allow us to build actively managed portfolios that are durable and potentially capable of withstanding the shock of both corrections and bear markets. These portfolios are diversified by asset classes and strategies and are able to be delivered at a new lower fee. For more information on these portfolios, call us at 800-347-3539, ext. 2, or email us at sales@flexibleplan



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