4/25 Kelly Letter Topics
Weekly market review
Earnings season
SEC GS politics
Fin reform toothless
Money always talks
Greece still sinking
Japan's sliding credit
AAPL > MSFT
Falling bullishness
Grant on fin reform
Unwinding hedges
Who will buy JGBs?
Tempur-Pedic
Of snow and stocks
2010 EDITION
Much has changed; good investing has not
The Neatest Little Guide to Stock Market Investing, 2010 Edition
I've been following the debate on whether the pessimists are correct or not, and so far the market is going our way after your bullish call [one month ago]. I have no idea what will happen next. However, my one comment is that I worry about the "sure thing." It is "common knowledge" that the market runs up at the end of the year. It "always happens."
It may well happen again, as it usually does. It's just that when we count on something to "always" happen, the market has a habit of doing what it likes, and sometimes the sure thing evaporates.
I get worried when everyone agrees.
I do, too, but there's nothing near a bullish consensus now. In fact, the switch from cautious to bullish here was met with heavy resistance, even insults.
We're one month into solid returns, but frustrated bears are only nibbling at the idea that the market might rise after all. Read forecasts carefully and you'll see a lot of reference to downside risks remaining high, the October surprise lurking in the shadows, and such. We've decided to charge ahead in full bull regalia despite those fears -- which are always present, by the way -- and so far we've been right.
Even the Fed is hedging, though:
St. Louis Fed President William Poole said Tuesday that the Labor Department's recent employment report implies the economy is not in as much danger as was feared, but conditions remain delicate. On the same day, San Francisco Fed President Janet Yellen said she is uncertain whether further rate cuts will be required to stabilize the economy. "Financial markets appear to be stabilizing, but they have not returned to normal and are still fragile," said Poole. He cautioned that housing will likely remain weak for several more quarters. Yellen believes the rate cut helped to contain downside risk, but she said it is too early to tell whether the economy "dodged a bullet." "I have a totally open mind about what, if anything, is going to be needed from here on in," she said. [Full Article]
While it's true that there's a seasonality to the market, saying everybody is on to it overstates the case. In fact, that "everybody" is generally the Stock Trader's Almanac, which advocates a mechanical strategy that looks to be getting into the market about now for what it dubs the "best six months." I criticized the Almanacyesterday for its rough conclusions about the presidential election cycle, and its best six months strategy deserves equal disdain.
Creating skepticism around the strategy doesn't even take financial analysis. Just think about it. Don't you suppose that if winning in the market were as easy as putting your money in every fall and taking it out every spring, we'd all just create an automatic timer with our brokerage accounts? Sure we would.
Unfortunately, the strategy isn't all it's cracked up to be.
From 1995 to 2005, the Almanac's prized strategy of combining its "best six months" approach with MACD timing to get better seasonal entries and exits returned a cumulative 225%. Just owning the Nasdaq 100 returned 332%, and that's including the dot com crash. How much investment acumen does it take to just put your money in a Nasdaq 100 index fund or ETF? Not much, yet it was far better than the Almanac's seasonal timing strategy.
If you really want to see the lack of research going on at the Almanac, compare its performance to my permanent portfolios. My Maximum Midcap strategy returned 526% just as a lump sum. The extreme volatility of the strategy combined with regular monthly investments did far better, still. In fact, it's that pairing of extreme volatility with assured recovery that makes the strategy so perfect for the way most people invest: by sending additional funds each month or quarter.
One weakness of the Almanac is that its strategies are based and proven with data going back to 1950. That sounds good in theory because they're tried and true. Unfortunately, they appear to be a bit old and stodgy. They certainly don't stand up to the "what have you done for me lately?" rule that most investors employ, whether consciously or not.
For example, the Almanac is proud that its "best six months" with MACD has not had a losing year since 1983. Nice soundbite, but it doesn't mean much when looking at the bottom line. Volatility is your friend when it eventually moves upward. From 2000 to 2005, the Almanac generated these annual returns: +5%, +16%, +6%, +8%, +2%, +8%. Not a losing year, true, but not much in the way of winnings, either. Maximum Midcap speaks for itself.
So, I wouldn't worry about the impression that everybody is on board for an end-of-year recovery. First, they're not. Second, that impression is mostly from the Almanac's touting of such seasonality, which has not proven to be the most profitable approach to stocks.
This comes up every year, we get through it every year, and I'm sticking with my forecast of a strong medium term -- for reasons that have nothing to do with the Almanac's strategy.
Jesse wrote: "I found an interesting article on the effects of presidential elections on stock prices."
From the article Jesse cited:
In The Stock Trader's Almanac, 2004, Yale Hirsch notes that based on his studies, "Presidential elections every four years have a profound impact on the economy and the stock market. Wars, recessions and bear markets tend to start or occur in the first half of the term, and bull markets in the latter half."
The Stock Trader's Almanac is a very rudimentary tool, useful for big picture prognosticating and interesting historical tidbits, but nearly useless when it comes to actually making investment decisions.
Recently, for instance, the Almanac was out of the market for the powerful rally that began in summer 2006, and has missed out on the current rally that began more than a month ago, plus all of the heady gains back in May. Why? Because it uses a mechanical seasonal timing method called the "Best Six Months" with MACD analysis to try determining when to get in and out of the market in October or November and April or May. Some people swear by it; I swear at it.
So it comes as little surprise to me that Yale Hirsch concludes in typical wide-cut Almanac fashion that rallies tend to occur in the latter half of a president's term. How would you have felt back in Bill Clinton's second term in 1997 and 1998 when the market was supposed to do poorly but the Nasdaq gained 71%, or in 1999 and 2000 when the market was supposed to do well but the Nasdaq saw its peak and first half of the crash.
"Yes," they say, "but look how the cycle did with President Bush's first term."
Fine. The Nasdaq lost 46% during the first two years of President Bush's first term. However, that was the follow-on to the bear market that began in the last two years of President Clinton's second term. Moreover, the supposedly rough first two years of President Bush's second term were good. The predictor failed there.
Looking over the spottiness, you can see why I'm loath to call the presidential election cycle much of an actionable trend. Yes, there's something to it. It's worth factoring in, and I admit that this being the third year of President Bush's second term helped make my bullish call on this year back in January. However, by itself, it's not much to build a strategy around.
What there is worth building on is not best presented by the Almanac. For a more illuminating look at the facts in a concise article, stop by CXO Advisory Group. It concludes:
There appears to be some connection between the presidential term cycle and stock market performance, with Year 3 the best and Year 1 the worst.
CXO improved on the Almanac by narrowing down the best part of a presidency to a single year and the worst part to another single year. That's a helpful leap over the Almanac's sloppy half-and-half ballpark assessment.
Probably the best comment on all of this is from the article Jesse cited. It concludes:
Even where patterns exist, there is enough variability that it is risky to try to anticipate specific turns in the market.
That, ladies and gentlemen, is why I'm still in business.
