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

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Tuesday February 1, 2022. 

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.

Steady And Consistency Win In The Long Term

Long term readers know that we at MyPlanIQ advocate long term investing. To be more precise, we advocate investors to pick a few presumably sound strategies such as our Strategic Asset Allocation (SAA)  and  (Asset Allocation Composite (AAC) and stick to them for a long period of time. In light of the current market volatility, we again delve into this topic a bit more. We then will look at the current market situation. 

Investing is a statistical process

Unfortunately, like it or not, financial markets, especially for stocks and other risk assets (such as REITs and commodities), are inherently very random, albeit there exist certain inefficiencies. The nature of the randomness for asset prices implies that it’s very unlikely for anyone to achieve constant deterministic returns for any period of time. 

However, we have also observed that given a long enough time, if one were to hold stocks such as a well known broad base stock index fund like S&P 500 index fund (not individual stocks or narrow sector funds) for a long enough period of time, it’s likely to result in a positive return in that period. 

The question is how long?

In July 17, 2017: Long Term Stock Holding Periods For Retirement, we stated that to achieve a reasonable return, ‘one should hold S&P 500 for 20 years while for a long term timing portfolio, at least 10-15 years (preferably 15 years).‘ 

In April 24, 2017: The Long Term Stock Market Timing Return Since 1871, we showed the following table:

  S&P Rolling 10 Yr S&P Rolling 15 Yr S&P Rolling 20 Yr  MA Rolling 10 Yr  MA Rolling 15 Yr  MA Rolling 20 Yr 
AVERAGE 9.2% 9.2% 9.3% 9.4% 9.4% 9.4%
STDEV 5.0% 4.1% 3.3% 3.9% 3.1% 2.3%
MIN -4.0% -0.3% 2.1% 0.9% 2.6% 3.2%
MAX 21.1% 19.3% 17.9% 19.4% 16.7% 15.3%

In the above, it looked at annualized returns on a monthly basis of rolling periods (10, 15 and 20 years) for both S&P 500 (total returns including dividend reinvested) and a strategy that holds S&P 500 if it’s above its 10-month moving average, otherwise, it holds cash (the calculation assumes cash yields 0 interest, which is conservative and probably misses 1-2% annually). The data spans from 1871 to 12/2016. 

What the above tells us is that since 1871, if an investor started to invest in any given month and held S&P 500 index fund for 20 years, she/he will be guaranteed to achieve minimum 2.1% annual return for any period. Also, on average, holding S&P 500 for 20 years would achieve 9.3% annual return.  However, the investor might encounter negative returns if the holding period were 15 years or 10 years. 

In contrast, the MA (Moving Average) investor would not encounter any loss for any 10 year period and longer. It’s also remarkable that on average this strategy yields a bit higher than merely holding S&P 500 all the time. It also reduces maximum drawdown to one third of the buy and hold (of S&P 500). 

So the steady and consistency indeed win in a long term — a period longer than 10 or 15 years, preferably 20 years or so. In fact, both methods yield similar results on average. However, on average means if one keeps doing this for more than 140 years. 

Of course, it’s also possible to devise an investing strategy that can possibly result in positive returns for a shorter period (than 10 years, say). A simpler way is just to reduce stock allocation and allocates more to bonds. However, it becomes increasingly difficult to achieve overall returns that can be comparable or better than stocks (such as S&P 500). 

The above discussion tries to show that as markets are inherently random, it’s important to remember that in order to achieve the average expected result, one needs to stick to that strategy for a long period of time as the longer you stick to a strategy, the more samples you have gone through and the law of large number implies that it’s more likely your return will converge to the expected return of that strategy. 

Again, holding S&P 500 indefinitely is one strategy (a simplified SAA). Using MyPlanIQ’s AAC is another one. The point here is that regardless what strategies you use, you have to give them enough time. 

What the above means is that it’s normal to experience short term volatility or underperformance. For example, in terms of MyPlanIQ’s AAC or TAA (Tactical Asset Allocation) strategies, it’s possible for them to underperform against S&P 500 for a period of as long as 10 to even 15 years. But given long enough time for markets to go through bull and bear cycles, it’s very likely these strategies will achieve better or comparable returns with much lower interim loss (i.e. so called maximum drawdown or a maximum loss from a peak to a subsequent trough in that period). 

Of course, there is also a possibility that the strategies we are picking are inherent inferior, even compared with buy and hold S&P 500 or SAA. If this is a real concern or something really bothers you, it’s a lot more beneficial to start to re-examine the strategy employed (like the ones MyPlanIQ has) and see whether 

  1. Any further insight into the strategy’s weakness and any better alternative. Recognizing the fact that some of ‘weakness’ is inherent and there will be always ‘weakness’ (otherwise, again one would be in a holy grail to become world wealthiest person if such a strategy exists). What matters is whether the alternative is better (not best or with no weakness at all).
  2. Any implementation issue in practice: sometimes things are good on paper but in practice, it has some inherent difficulties to implement. For example, a tactical strategy like MPIQ’s tactical ones require some monthly rebalances or trades that, if missed, can be detrimental. However, an SAA strategy will not deviate too much even if you miss a few rebalances. On the other hand, SAA can suffer huge interim loss that can become unbearable to many people, precisely at some market lows. Often, unfortunately, these people bail out in those difficult times, creating some permanent damage to their finance health. 

To summarize, doing enough due diligence to understand investment strategies is paramount. After that, you’ll need to stick to those strategies thick or thin for a long period of time. That’s why it makes investing so hard or so easy, depending on whom you are asking. 

The current market correction

Well, it turns out the so called Santa Claus rally was short-lived: the correction that started in November has continued since day one this year. 

Looking under the surface, we actually can find that markets have started to correct those high flying profitless stocks since February last year. This is especially pronounced for ARK Innovation ETF (ARKK) that primarily invests in high flying tech companies that mostly are unprofitable. 

In the above, we also include MTUM (iShares MSCI USA Momentum Factor). This ETF represents momentum stock factor and perhaps is one of the best in this category.It invests in mostly high growth stocks. 

In fact, ARKK has now corrected more than 50% from its peak in February last year. We also see that MTUM hasn’t performed well at all last year. In 2021, it was again a year when nothing worked better than a simple S&P 500 or Nasdaq 100 index. The top 7 holdings in S&P 500 are all large technology companies and now they represent more than 26% of the index!

Market internals have deteriorated drastically since the New Year. For example, the percent of stocks in Nasdaq composite index that are above their 200 day moving averages is now 22.6%, reaching to the level in March 2020:

Economy-wise, both retail sales and industrial output disappointed, but we still see a healthy expansion compared with the same period last year: 

Interest rate rose while CPI (inflation) is now more than 7%. This is especially important as the rising inflation might force interest rates higher, derailing the ultra rate/loose monetary environment that’s been the main reason for stocks to be persistently at historically high price levels. This investment ‘regime’ change might turn out to be the main factor driving stock prices much lower in the coming months. 

At the moment, we are seeing corrections, especially among those growth oriented stocks (specifically tech stocks). However, as this correction hasn’t spread to every market sector (for example, value stocks especially bank stocks are holding up well for now), for now, this is not a uniform market downtrend.

Market Overview

We are now into the earnings report season. Based on FactSet, S&P 500 companies were expected to have earnings growth for Q4 2021 as 21.4% on December 31. By 1/13/2022, the blended earnings growth was 21.8%, a little better than the previously expected. 

In the coming months, we expect markets will become more and more volatile as many major factors including the pandemic and inflation are coming to play. Given the extremely high level stock and bond prices, we call for caution and advocate the following practice:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation is still extremely high by historical standard. For the moment, we believe it’s prudent to be cautious while riding on market uptrend. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.  

We again would like to emphasize that 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.

We wish everyone a happy holiday season. We all deserve one after this long pandemic ordeal!

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