Alpha Power Investing Newsletter

October 13, 2015

Is You Is Or Is You Ain't


A bear market, that is.
 
Plenty of very smart people think we're in one. Maybe they're right. Problem is that none of them that I know of tagged the 2008-09 bear market in a timely fashion. Add to that the well-known fact that markets typically go further and longer than most experts expect - both ways - up and down.
 
There is, of course, a legion of smart people who recognize the problem of prediction and who tell us to forget it - just buy and hold. They are backed up by reliable studies going back decades which document that buy and hold investors do much better over the long-term than market timers.
 
The problem with buy and hold is that starting points matter…a lot. An investor starting in 1966 with a portfolio equivalent to the S&P 500 suffered through two big bear markets shortly thereafter and a rugged bout of inflation. Break even didn't come until the late-eighties.
 
If you started in 1974-1981, on the other hand, you made out like a bandit until 2000, enjoying a twenty-year bull market recovery from the inflationary tortures of the sixties and seventies.
 
The ideal investment path is to find a solution to the problem of starting points. Is there a way to be a long-term investor while systematically avoiding dangerous starting points and capitalizing on the bull markets that follow?
 
Alpha has a suggestion. It's called "seasonal investing". Our Mid-Cap Power Index Managed Account strategy is based on it. This strategy starts with two premises. The first premise is that the stock market is significantly more robust from late-October to mid-May than it is for the rest of the year. The second premise is that during periods of robustness, small-cap and mid-cap stocks will outperform large-cap stocks.
 
Both premises are universal - that is, they are true for all developed stock markets globally.
 
Investors hate uncertainty, so they turn to what they believe to be reliable sources of information - namely experts. Wall Street is naturally more than happy to provide experts. They are, of course, optimistically inclined (why not, constant bullishness is rewarded two-thirds of the time) and tend to move as a herd. As a result, late in the year as investors prepare for the new year, the "experts" make their predictions for the next 12-18 months. These tend to be overly optimistic and they are influential. Investor expectations are lifted, skepticism is sidelined for a while, and stocks tend to enjoy a 6-7 month respite from unpleasant "facts".
 
By the end of April, however, earnings are appearing and often fall short of the "experts" predictions. That's why the six-month period from May to November has been up just 59% of the time since 1950 (Dow Industrials - 1950-2013). Furthermore, the rate of appreciation during this six-month period, which we call the "dead zone", has been slightly negative for the past 65 years. From our point of view, the logical conclusion to be drawn from this is that long-term conservative investors should simply avoid the "dead zone".
 
The chart below demonstrates this clearly.
 
 
The effect of seasonality on the S&P MidCap 400 Index since its inception in 1981 has been even more profound. Stretching the "power zone" to seven months (November to June) results in a compound rate of return of 13.1% annually (ending May 31, 2015), with just four losing periods since the inception of the S&P MidCap 400 Index 34 years ago: -2.3% 1981-82; -9.3% 1983-84; -1.8% 1993-94; -1.9% 2007-08. Not only are the returns superior, but investors are exposed to market risk just 60% of the time.
 
We add a couple of nuances to this simple strategy to boost returns without substantially adding extra risk. To read about the complete strategy, go to the Strategies and Performance page of our website at www.alphaim.net and download the Alpha Mid-Cap Power Index MA brochure.
 

Sincerely yours,
Jerry Minton, Ph.D.
President
1-877-229-9400, Ext. 11
www.alphaim.net

Disclosure: Past performance is not a guarantee of future performance.

 
© 2015 Alpha Investment Management, Inc.
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