November 5, 2018: The ‘Right’ Or ‘Wrong’ Decision

Nov 6, 2018 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, December 3, 2018. You can also find the re-balance calendar for 2017 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

The ‘Right’ Or ‘Wrong’ Decision

Unless you aren’t paying attention, recently, stocks and bonds have gone through some big gyration. S&P and all other major stock indices had fallen more than 10% at one point in October. However, stocks have staged some meaningful comeback in the past several days. As usual, this has produced tons of reports/commentaries in financial media to analyze and proclaim ‘right’ or ‘wrong’ decisions on market direction. Some of them are technical, some of them are fundamental. But one thing is for sure: they are often conflicting: some says buy and some says sell. 

No one can be right all the time

The very first sense one should come to is that no one can be right all the time, especially for a short term.  Let’s look at some interesting fact: 

$1 million invested in the beginning of 1988 to 2017
  Total Worth at the end of 2017
VFINX only $20m
VFINX but goes to cash if that year’s return is negative $54m
VFINX but short the same amount if that year’s return is negative $114m
VFINX but short the same amount if the month’s return is negative $86billion

In the above table, we look at investing in S&P 500 through Vanguard 500 index fund VFINX for the past 30 years from 1988 to 2017. If one can predict every year’s return correctly and goes to short (i.e. bet the index will fall) in that year, he/she would accrue $114 million by the end of 2017, $94million more than one would just invest in VFINX and do nothing. The real kicker is that if this person can predict every month’s S&P 500 return correctly, he/she would accumulate a whopping $86 billion in the 30 year period. So it’s not hard to see that the compounding can quickly add up: another 30 years like this would produce $86billion x 86 billion, more than the wealth of the whole world. 

The number can go even more ridiculous if one were able to predict daily market direction. 

The above simple reasoning is to show that from the simple arithmetic, one should recognize there is no way for anyone to be able to predict market direction correctly in every short term. So don’t search for ‘holy grail’ for no avail. 

Conflicting decisions can be both ‘right’ for a long term

In fact, the two totally opposite decisions can be both ‘right’: so long they serve for two long term strategies that are sound. For example, at this moment, buying stocks or liquidating stocks can be two conflicting decisions, one for Strategic Asset Allocation (SAA) and the other is for Tactical Asset Allocation(TAA). Both strategies have strong intuition backings, see, for example, 

and many other newsletters on the long term performance of the two strategies. Other sound long term strategies include 200 days moving average on S&P 500 index and even seasonality portfolio.

All of these portfolios/strategies can produce conflicting decisions at any one particular time. Some are right for that short term and some are wrong. But for a long enough period, they all tend to produce reasonable returns.

 The ‘right’ question: good or bad strategies

Instead of heeding endless predictions/articles/reports from experts in financial media, investors actually should really ask a more fundamental question: am I following a good strategy? The secondary question is that am I staying the course even after I recognize that strategy is sound in the long term?

The reason: investing is a statistical process and its average can ONLY be achieved after some sufficient large ‘samples’ of data – in investing, that means long period of time. It all boils down to  the long term average and how large the returns are deviated from the average. The second factor is usually translated to the length of ‘the long term’. A more volatile strategy will take longer to converge (achieve) the average, thus requiring longer holding periods. See March 11, 2013: How To Evaluate Investing Strategies on this topic. 

We have discussed this topic several times. For us, a strategic portfolio requires minimum 15 years and preferably 20 years or more to achieve a reasonable return, while a tactical portfolio requires minimum 10, preferably 15 years or more to achieve such a return. See the following newsletter for more detailed discussions: July 17, 2017: Long Term Stock Holding Periods For Retirement. 

Finally, we want to point out one more time that the danger is to act based on a random decision because of some great experts’ prediction. If you want to follow an expert or a strategy, you have to continue to follow it, thick or thin for a long time (assuming you have done enough homework to understand and agree that the strategy is sound). Unfortunately, many experts give out such interviews/suggestions sporadically and there is hardly a way to rigorously follow them consistently. Those who follow these advices often end up following other advices later on, thus resulting in random or incoherent actions that are harmful to their investments. 

Although these experts might indeed make ‘right’ suggestions in their own framework, following them inconsistently is just no different from a random dart throwing. No wonder monkey dart throwing can produce similar or even better returns than an average investor! 

Market Overview

Although US stocks recovered somewhat last week, risk asset markets are decidedly in a chaotic downtrend. What made this downturn worse is that this time around, long term bonds are falling also (i.e. long term interest rates are rising), indicating investors’ concern on inflation. Whether the worst combination of weak stocks and weak bonds is realized or not will be seen in the next few weeks. Earnings wise, the growth for Q3 2018 has been really strong: with 74% of S&P 500 companies reporting actual results, the blended (actual and expected) earnings growth is 24.9%, much higher than 19.3% expected on September 30. However, the trouble is that analysts are now scaling down the 2019 expectation, only predicting 9% earnings growth for 2019, compared with 21% for 2018. Such a peak in earnings growth does not bode well with stock markets. Based on CFRA, this usually induces a market sell-off or even a bear market: 

The slowdown can be further exacerbated if trade war intensifies (plus other major issues such as the under expectation of tax cut benefits). At any rate, the economy and the stock valuation are close to or at a peak, it can only be tougher to satisfy already high expectation. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

As always, stay the course. 

In terms of investments, U.S. stock valuation is still at a historically high level and it might still have a bigger correction. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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