March 29th, 2008

Market corrections are great; bear markets are even better

One of the principals of my Market Timing Indicator (MTI) that I first started writing about on February 6 and have been regularly updating since dictates that there are times when, based on my back testing of the MTI, the optimal strategy is to “cash out” – own no stocks and be 100% in cash.

Academicians have written often and extensively about the penalty they see investors experiencing should they be out of the market on the biggest up days of the market. However, one of the best recent look at these studies was conducted by

Along these lines, one of the things I’ve been wondering for a long time is how Investors Business Daily appears to have such fabulous returns over extended periods. And the answer came in newspaper insert by a local Can Slim Private Clients asset manager. The insert says they”build and manage portfolios for clients using the CAN SLIM system”. As evidence, they included a graph of the performance a representative $100,000 portfolio vs the same funds invested in the S&P 500 Index. The CAN SLIM portfolio would have increased to nearly $320,00 while the SPY portfolio would have increased only to $125,000.

What really caught my eye, though, was they showed their top ten holdings as of February 29, 2008. I looked at the table, counted and saw only 8 items listed, not 10. And the number one holding, representing 64% on the portfolio was none other than Cash!

“Market corrections are great;bear markets are even better”, or so I wrote in “Running with the Herd”, the title of my upcoming book. I went on to write:

“There are two ways to measure stock market performance: 1) in terms of absolute returns and 2) relative to a benchmark, like the S&P 500 (an RSI). Even though the absolute return on your portfolio increases, it may still be performing poorly if its increase is less than the S&P 500 (making the RSI decline); conversely, a decline in your portfolio may not be bad if it declines less than the S&P 500 Index. The RSI really skyrockets merely by your quickly moving chunks of the portfolio into cash when the market is in bear mode and thereby immunizing it from further losses.

Remember, the average investor is more emotional about losses than about gains. Granted, it’s downright depressing seeing a portfolio being pulled lower by the market but, by shifting your focus to the RSI, you almost start rooting for the market to move even lower. Rather than feeling depressed about the market’s declines, you begin to feel exhilaration at seeing your RSI leaping ahead. Having the RSI increase while the market declines is as good as buying winning stocks when everyone else bought losers.”

Those of us who’ve had big chunks of their portfolio in cash have preserved their capital and are well positioned to jump back into the market with more than both feet (on margin, that is) when the MTI signals that risk has been reduced. That’s going to be a while off, unfortunately, but it feels pretty good seeing your portfolio staying relatively in tact while most stocks are beginning to be offered at discount prices.

Stay calm, stay cool, be patient. The time for stock selection will come but it’s not right now.

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