Alpha Power Investing Newsletter

November 6, 2018

What Goes Up…Comes Around

Please forgive the mixed metaphor in this month's title, but the recent action of the financial markets will lead to that kind of behavior. The Alpha strategies rely on a variety of the most reliable and time-tested seasonal trends demonstrated by the financial markets. The acknowledged weak link in this approach is that there will be times when things do not work out as planned. Of course, since there are no "perfect" investment strategies, this statement is true of all investment strategies. The key then to long-term success is having and maintaining the emotional and financial wherewithal to stick with your strategy during those occasional periods of relative underperformance.

One of the staples of several of the Alpha strategies is holding low volatility treasury bonds during what we refer to as the "Dead Zone" - ostensibly encapsulating the months of June through October. Our strict adherence to this approach can - and does - at times result in underperformance relative to the major market indexes. Yet the net effect over time is a steady, low volatility return which avoids a great deal of stock market "pain".

Figure 1 displays the cumulative growth of $1,000 invested in the Dow Jones Industrial Average (using price data only) ONLY during the months of June through October starting in 1949.

There are several key things to note:

  • The Dow was up during the "Dead Zone" 8 of the past 10 years (through 10/31/2018). This most recent period is visible at the far right hand side of the chart in Figure 1.
  • As it turns out, this type of action is not at all uncommon. As you can see in Figure 1, within each and every decade there has been at least one multiple year period during which the stock market advanced - sometimes quite strongly - during the "Dead Zone" months. During these times, unless bonds rally by an equal amount, this can result in short-term underperformance for our strategies.
  • By our count there have been at least 12 previous times when stocks rallied over a multiple year period within the "Dead Zone" months.

But here are the key things to remember regarding all of this:

  • Every one of those previous "rallies" were invariably followed by significant market declines during subsequent "Dead Zone" periods.
  • Interestingly, the cumulative price gain for the Dow during ALL "Dead Zone" periods starting in 1949 is a mere +18.6%.
  • To put this in perspective, over the past 37 "Dead Zones" (1981-2017), intermediate-term treasury bonds have returned roughly +280%, and have done so without the significant volatility or potentially debilitating drawdowns experienced by the major stock market indexes.

2018 is a reminder that nothing lasts forever - particularly in the financial markets - and that two of the gravest dangers facing any investor are, 1) complacency, and 2) extrapolating recent performance ad infinitum into the future. In late-September it seemed a foregone conclusion that the "Dead Zone" would witness another stock market gain. By the end of October, several of the major market indexes had fallen into a loss for the period, and some were even down for the year.

Looking forward, November 1st marks the start of what we refer to as the "Power Zone" period, which extends through May 31st of 2019.

Starting in November 1981 - May 2018, the S&P MidCap 400 Index during the "Power Zone":

Clearly, stock market performance has been favorable during the "Power Zone". Once again, however, the proper approach is not to extrapolate these results and "assume" that the next seven months are "sure" to be favorable. The proper approach is to allocate a reasonable amount of capital and - most importantly - to continue to do so over the course of many years in order to capture the long-term edge this trend is designed to exploit.

Jay Kaeppel
Vice President and Director of Research
Alpha Investment Management, Inc.

Disclosures and Disclaimers: Past performance is not a guarantee of future performance. The returns illustrated in Figure 1 and Figure 2 do not represent actual trading and is not representative of any Alpha Investment Management strategy. The data does not include management fees or the cost of funds, trading, or other expenses. The illustrations are designed to quantify the effect of certain time periods (as specified) on the Dow Jones Industrial Average and the S&P MidCap 400 Index. Indexes are not investment vehicles and persons cannot invest directly in an index. The Dow Jones Industrial Average is a price-weighted measure of 30 U.S. blue-chip companies. The index covers all industries except transportation and utilities. The S&P MidCap 400 Index is a market-weighted index of 400 mid-sized companies with total market capitalizations from roughly $750 million to $3 billion dollars. Stocks in this index represent companies from industries including information technology, energy, health care, financial, manufacturing, etc. The data used to construct the illustrations was obtained from third-party sources. While Alpha believes the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.

Alpha Investment Management, Inc. is a SEC registered investment advisor. Such registration does not imply a certain skill or training and no inference to the contrary should be made. The information and opinions expressed in this document are for informational purposes only. Any recommendation or opinion made in this document may not be suitable for all investors. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

© 2018 Alpha Investment Management, Inc.

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