Rule #3 – Never Lose Big

Rule #3 – Never Lose Big

Monthly Outlook: June 2019 

A lot of experience and research supports our thesis that you can invest better than average if you’ll follow our three simple rules: Rule #1, costs matter so keep them low so more of the return flows through to you. Rule #2, stock picking to out-perform the market is really hard so focus, instead, on actively managing your allocation. And Rule #3, the most important of all, is Never Lose Big! Our iFolios strategy was carefully designed with these 3 Rules in mind. And today, with many markets tipping over to new downtrends, is the perfect time to review how we manage portfolios to try and never lose big. Before we do, let’s review the markets. 

May proved to be a tough month for investors. The S&P500 lost 6.5% in May, giving back the 6.5% gain it had achieved from February through April.  In fact, the S&P500 is 2,750 today and it was 2,750 eighteen months ago. If you’re tempted to yell to the markets, “Do something!” you’re likely to get your wish. In reviewing 90 years of stock market history, only 6% of the years were flat (within 2% of 0). Most of the time markets have either trended up or down, not flat. But be careful what you wish for because the next sustainable trend for stocks just might be down. Bonds, boring old bonds, have been pretty decent performers this year. Interest rates (the 10-year U.S. Treasury) recently peaked at 3.2% in November 2018 and have steadily declined to just 2.1% today, seven months later. Remember that interest rates and bond prices go in opposite directions.

Never Lose Big

They key to risk management is to have a plan in place before you need it. What are you going to actually do, or your advisor do, to limit losses? If the answer is something like “we hold quality stocks” or “you have to keep the long-term view” then you’re not really doing anything. In a bear market, even quality stocks go down, and sometimes a lot. No, the only way to avoid the big loss is to reduce your exposure to the market. In simple words, you have to sell before the losses get too big and to do that you need a plan. When a market, any market, tips over to a downtrend (price moves below its 200-day moving average trendline), we think it’s prudent to sell or trim your exposure to that market until it starts trending higher again. You simply cannot make money when a holding is below its trendline. It’s math.

The dip in May was enough to push nearly every equity market below its 200-day moving average trendline. For this reason, we necessarily have been selling a lot of our equity ETFs to manage risk and avoid any possible big loss. Today, the down-trending markets include: Asia, Emerging Markets, Europe, US Value, US Small, US Dividend, S&P500, Dow Jones Industrial Average. We’ve trimmed them all and have significant cash allocations for safety. Hopefully you get the big point: Right now is the time to trim/sell and de-risk. Yet, we know of countless investors and blue-chip advisors that will do nothing. Please feel free to share this timely Outlook with any of your friends in this situation.

How Do You Know?

We established that most stock markets have tipped to downtrends and we’ve sold/trimmed our positions in very meaningful ways. But how do we know if this is the beginning of a big bear market? Simple answer: We don’t. We just know that equity markets are trending down. Whether it’s a 5% dip or a 50% bear market, we think it’s prudent to sit out the storm and take cover. At the same time, valuations are at (and have been for a year) record high levels that often coincide with market tops. GDP, earnings, and employment are all still strong. But they always are at tops, before they fall. Lastly, political instability, growing concern about global trade, rising tension with many countries (China, Iran, Mexico and others), all portend global economic slowdown. So, we can plainly see that markets have tipped to downtrends, and, when combined with high valuations and global economic slowdown, the fuel is there for the downtrend to be a bit more than a dip. We’re safely underweighted stocks and will watch, carefully, for the next uptrend. Bonds and cash are better bets for now.  We’ve been through many downtrends and we’ll get through this one, as well. And we’ll never forget Rule #3, Never Lose Big!