A Complete Strategy Needs a Plan for Offense and Defense

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Something that caught our eye recently was a New York Times article entitled “Once You’re out of the Market, It’s Tricky Getting Back In.” There are some oversimplifications in the piece, like a quote that begins “Jumping out of the market is a mistake…” However, we wholeheartedly agree that “…getting back into stocks can be a more difficult decision than leaving the market in the first place.”

In March, at the height of panic selling, investors pulled $326 billion from mutual funds and ETFs. Although it ended more than decade ago, the global financial crisis was the last real bear market. As we now know, many investors who exited the market never had the stomach to reenter, much to their detriment, even if their initial decision to exit the market was the correct one.

Image Source: John Hancock Investments

Although remaining out of the market could now be viewed as a mistake, and a costly one, there was plenty of cause for investors to be fearful at the time. Younger investors may or may not have an appreciation for the pervasive fear that existed from Main Street to Wall Street. There were several events surrounding the financial crisis that had never occurred and/or were believed to be “impossible” e.g., the fall of Lehman Brothers and the nationwide collapse of home prices. At the time, the notion that the global economy could collapse did not seem farfetched.

On the TODAY show on October 6, 2008, at which point the S&P 500 was already down more than 32% from its 2007 peak, Jim Cramer said “Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now.”

Even after the US equity market had hit what we now know was its bottom in 2009, there was still no shortage of headlines that would have given all but the most steely, disciplined investors qualms about deploying capital into the market. An April 3, 2009, New York Times headline read, “663,000 Jobs Lost in March; Total Tops 5 Million.” Chrysler filed for bankruptcy on April 30th, followed by General Motors in early June. All of this to say, that even as the recovery of the US equity market was underway, there were still plenty of reasons to be skeptical that the worst was over.

Hindsight, as the saying goes, is 20/20 and as a result we tend to believe that past was predictable and that we would have sidestepped the pitfalls that others fell victim too. However, many of us are probably feeling a bit more circumspect right now with the heightened levels of uncertainty in the market and the March sell-off still fresh in our minds. Investors who went into March without a plan for raising cash and rode the market down and back up you may be feeling like they dodged a proverbial bullet. Others who exited positions without a plan for reentering may be looking at the current market environment in which the Nasdaq 100 Index (NDX) hit a new all-time high 10 days ago while unemployment is north of 10% and feeling only fear - fear of missing out (FOMO) and fear of getting back in just before the market pulls back. If you don’t have a plan at all or if you only have a system for getting defensive but not for putting the offense back on the field, this is the perfect opportunity address that – before hindsight bias sets in.

We regularly receive calls from advisors asking which indicator(s) or system they should use to determine when to raise cash and reduce market exposure and there are several options to choose from on the NDW platform. However, having a plan for re-entering the market often receives less attention. In an environment like the one that existed in 2009 or the one we find ourselves in today, making the call to get back may be even harder than making the call to get out. Therefore, it is imperative to have a plan for both halves of the equation worked out in advance. As we have seen, over the long-term, only having a risk-off plan could be worse than having no plan at all.

So, which indicator(s) should you use? This is something that many people seem to want to make overly complicated. Fortunately, the answer is simple. You should use the indicator(s) that you understand, feel comfortable with and that you can explain to your clients to make them comfortable with the plan in place. There will be points when any indicator will tell you to raise cash too early or get back in the market a little bit too late. Although we consistently look for ways to improve the tools we offer, no market indicator is perfect, and it should raise immediate red flags if anyone says they have one. If someone had a system for perfectly identifying market tops and bottoms, why would they share it when they could earn virtually unlimited sums by keeping to themselves and trading on it?

A good indicator should be like the navigation system in your car – it provides a route to get your destination with as few detours as possible. However, you may find the first route it suggests isn’t necessarily optimal for you (or your client). If you’re a right-lane-of-the-highway, cruise-control-set-to-60 type of driver, then a route that has you zipping through city streets may not be the best route for you, even if it would get you there five minutes sooner. The point is, the best navigation system or indicator is one that gets you to your destination and does so by providing a route that you will follow. After all, you’ll arrive at your destination much later if you abandon your aggressive through-the-city route halfway through than if you had just taken the slightly longer highway path in the first place.

Dorsey, Wright & Associates, LLC, a Nasdaq Company, is a registered investment advisory firm. Registration does not imply any level of skill or training.

Unless otherwise stated, the performance information included in this article does not include dividends or all potential transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

Nothing contained within the article should be construed as an offer to sell or the solicitation of an offer to buy any security, nor as a recommendation to engage in any transaction or participate in any strategy. This article does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not soliciting any action based on this article. It is for the general information of and does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation (express or implied), investors should consider whether the security or strategy in question is suitable for their particular circumstances and, if necessary, seek professional advice.

© Nasdaq Dorsey Wright

© Nasdaq Dorsey Wright

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