Market insights and analysis

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

2nd Quarter | 2022

Market insights and analysis


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

Overnight change?

By Jerry Wagner

The calendar says that now it’s spring in the Northern Hemisphere. It arrived at 11:33 a.m. EST on Sunday. On Saturday, it was winter. On Sunday, it was spring. Just like that, an overnight change in seasons.

The lake behind my house also changed overnight. On Friday, I went to bed, and the lake was frozen. But when I awoke on Saturday, it was an ice-free lake as far as the eye could see.

But did everything actually change overnight as if some celestial power had switched on a light? First, it was dark … then, it was light.

Not really.

The calendar date for the beginning of spring is just a recognition of an astronomical event. It’s the spring equinox. Or, translated, it’s the time of “equal night” when the sun marks its northern trek with a crossing over the equator, and day and night are about the same length.

Yet, for meteorological purposes, spring begins on March 1. And in China, spring is celebrated six weeks before the spring equinox.

Furthermore, even though the sun crosses the equator when the spring equinox occurs, we know it has been traveling northward across our globe since the winter solstice in December. The calendar may change overnight, but the process leading up to that date was a long time coming. This is especially so here in the northern U.S., where we experienced many cold and snowy days awaiting its arrival.

And that lake behind me didn’t actually change overnight. We had a week of warm weather, and the ice just kept melting. A warm Friday night completed the unfreezing process.

The buildup to a sudden switch

With tactical investment strategies (formerly known as “market timing” strategies), change also seems to occur overnight. One day, you are in a “buy mode”—fully invested in stocks. The next, you are selling. All your assets are in defensive positions, such as money markets, bonds, and gold.

But in reality, the process evolves, things change over time.

For example, in their simplest form, momentum strategies are determined solely by the relationship of today’s price to a past day’s price.

But the length of the lookback time between that past price and today’s is a measure of the length of time over which the process of change occurs. At one time (in fact for most of stock market history), the direction of the change over a single day could be used by investors to trade stocks successfully. But with the advent of computerized trading in the 1990s, that edge slowly faded away.

Today momentum has to be measured over months by market technicians to be deemed sufficiently persistent to be profitably traded. Using a more extended time frame between today’s price and the past price reduces the occurrence of whipsaws (frequent, nonproductive, in-and-out trading). But, it also means that trading at or near the tops and bottom of a price trend is impossible.

For example, trading based on being over or under the 200-day moving average of the S&P 500 Index avoided some, but not all, of the fall from the market top in October 2007. Similarly, such an approach signaled investors to buy back in at lower prices than where they exited. Still, it was several months after the market bottomed in March 2009.

The process of change must work itself out. A period of time must occur that allows for price to reverse—falling prices must rise off a bottom to buy, or rising prices must fall from a top to generate a sell. Both signals take time to develop as investor expectations and behavior evolve.

In the meantime, momentum traders must trade farther away from an idealized market top or bottom. This disadvantage is just a matter of time. We pay that price to get the risk-reduction advantages of momentum trading.

How do momentum investors make up the difference? If they lose a little ground when they sell and buy, how do such investors catch up with the indexes used as their benchmark?

There are two answers to that question:

1. Frankly, some of these investors don’t ever make up the difference as measured in absolute price gains. But risk-adjusted returns can be better since they often avoid some of the downside losses when prices fall.

2. Momentum investors can overcome the gap by how they invest. They may be making gains in their defensive positions while index prices are falling. Furthermore, when these investors return to the market, they can target the fastest-gaining stocks, funds, or ETFs or use leverage to catch up and surpass the index quickly.

More complicated tactical strategies than momentum are usually based on multiple signals. Instead of trading when just one of them switches direction, a number must change direction. Waiting for that also moves the trader away from the ideal buy and sell price.

Why don’t market professionals trade a single signal aimed at trading at the ideal time? Unfortunately, no one has found a sole indicator that is always right. After testing thousands of strategies myself over the last 50 years, I don’t believe anyone ever will accomplish that feat. In my experience, the best approach is to trade many signals that have a better-than-even probability of success. Realize that you will not be able to catch the absolute bottom or top of prices in your trading.

Preparing for “overnight change”

While some events appear overnight, seemingly out of nowhere, upon examination, we often learn that they have been in the process of “appearing” for a considerable period. Russia had been building up troops on the Ukrainian border since last spring. The COVID virus first appeared in China at least three months before it appeared in the U.S. And oil prices (USO) and most other commodities (SPCSCI) have been rising for a year, signaling inflation well before the invasion of Ukraine.

Because change usually occurs over time, market technicians can build indicators that can recognize that change may be coming. Doing this requires knowing what to look for and having the tools developed to take advantage of the opportunity. That’s where seasoned investment managers come into the picture. They do the research and employ the methodologies for you.

But since change occurs over time and not overnight, we, as investors, have to realize that all investment managers can do is put the probabilities on our side. They cannot sell at the ultimate top and buy at the absolute bottom.

Similarly, no matter what the calendar says, we all eventually know when spring has sprung. Somehow, all the geese seemed to know to return to our lake this weekend. (They are everywhere!) But, for the rest of us, we only know that we’re now past the spring equinox and that the probabilities are that summer is nearer. We’ll only know for sure that spring has come when we can look back in hindsight and see that winter’s over.

May the current winter in the stock market and geopolitical politics be over soon.

Comments are closed.