The extraordinary volatility seen in the markets for the past two weeks has clearly been a concern. Over the past two days alone, the S&P 500 Index has been up by more than 4% and down by more than 4% consecutively. We’ve used the recent volatility to reduce invested positions further, selling into strength on Tuesday (eliminating our exposure to both foreign emerging markets and to the Dow Jones Industrial Average). As these trends are now in decline, we purchased bear-market indexes in both our PLUS and tax Managed Growth Strategies which will give us the opposite daily performance of both of these indexes. If these new downward trends continue, these positions will appreciate nicely. We continue to hold invested positions in the NASDAQ 100 (which is comprised mainly of tech stocks) and U.S. commercial real estate. Both of these areas are also deteriorating; however, they are not yet to the point at which action is required. We also hold our bear market position in commodities which we purchased last week. As of the close yesterday, all of our bear market positions are trading above their initial purchase prices.
Our combination of invested positions along with our bear market positions essentially neutralizes our exposure to the markets for now. It would be normal for us to be up just a bit when the markets are down and down just a bit when the markets are up. This is important to know, and is perfectly normal for a trend-following strategy. As an example, over the past two days the markets have actually dropped further in value while our PLUS strategy has gone up by approximately 2%. (NB: our Appleton Group Portfolio doesn’t employ the use of bear market indexes). Given their current trajectory, it is very possible that both of our remaining invested positions (NASDAQ and commercial real estate) may also be eliminated from our portfolios over the coming weeks, positioning us at our most defensive posture possible in each portfolio.
Through it all, our bond positions have been steady, even appreciating in value. Interest rates have plummeted once again, offering investors little to help meet their minimum required return goals. For our retired clients, monthly distributions continue to be funded out of these stable assets – just as planned from the start.
So far, the market declines – while somewhat faster than normal – are unfolding as is typical of a major market turn: significant volatility, an emerging declining trend in the markets punctuated with occasional BIG up days. These are exactly the same conditions we saw at the top of the market in early-mid 2000 and at the second visit to the top of the market in mid-late 2007. Bull markets tend to go kicking and screaming, with large investors’ sentiment being swayed powerfully from fear to greed and back again. It is very possible that the emerging downward trend becomes extinguished by a flood of positive news (or at the very least, an absence of further bad news). Are we really on the cusp of another major leg down? No one can say for sure but if the current trend continues, doing nothing would be inviting disaster.
One month from now, I suspect we’ll know more about whether the recent volatility was anything more than a summer swoon. But the big picture tell us all we need to know about the health of the markets: a hypothetical $100,000 investment in the S&P 500 on December 31, 1999 today is worth only $92,971. The same initial investment in the NASDAQ is worth a mere $57,914. In short, buying and holding the markets is still not a good idea.