Alpha Power Investing Newsletter

January 2, 2020

The Importance of an All-Weather Strategy

It is a given that any investor would love to make "as much money as possible". However, the long-term reality is that very often investors who strive solely for maximum gain ultimately run into trouble that they are not prepared to deal with. This is because in normal times for the stock market, striving for above average gains typically involves assuming above average risk. And investors on the whole are notorious for overestimating just how much risk they are comfortable handling.

The past decade - and especially the last 12 months - has not been "normal times" as the stock market has marched relentlessly higher. However, good times (and bad times) NEVER last forever in the financial markets. Historically it is typical that just as investors get used to things going one way, things change. And things have been going one way for some time now (the stock market going up, U.S. stock indexes outperforming international stock indexes, growth outperforming value, etc.).

We do not possess the ability to predict with any degree of accuracy "when" things will change. However, we can predict with a high degree of certainty that things "will' change and that the current state of affairs will not last forever. Underscoring this, Figure 1 displays the Shiller P/E Ratio which highlights the fact that the current stock market level has only been more "overvalued" twice before - in 1929 and 2000. Following the peak in 1929, the Dow Jones Industrial Average lost -89% of its value and following the 2000 peak the NASDAQ 100 lost -83% of its value.

We are not making any "the sky is falling" proclamations. We are merely shedding light on what has happened in the past in similar situations and trying to keep investors aware of and focused on the "risk" side of the investment equation - which is easy to ignore when the market seems to be making new all-time highs every day. We should point out that the Shiller P/E Ratio should NOT be considered a "timing" indicator as it can stay over or undervalued for many years at a time. It is, however, an extremely useful "perspective" tool. When it falls to undervalued levels, patient investors can confidently begin to prepare for a long-term bull market. And when it reaches overvalued levels, as it clearly has at this time, alert investors need to begin making plans for how they will deal with the next bear market - whenever it may come - in order to avoid riding declines of -30% to -50% or more as we saw after the 1929 and 2000 peaks.

There are two primary problems at present: 1) the better the bull market the more complacent investors become (and the less interested they are in even contemplating the next bear market); and 2) timing the top is a pretty "iffy" proposition. This is where an "all-weather" strategy fits in nicely.

Where do Alpha's Strategies Fit In?
If you are familiar with Alpha's strategies you are likely aware that they are intended to be "all-weather" type strategies, i.e., they make money during a bull market but also hold the potential to make money during a bear market. We believe that these types of strategies deserve a place in all investors' portfolios regardless of where we are in the market cycle. If you are familiar with our strategies you are likely also aware that they de-emphasize stocks during what we call the Dead Zone months of June through October. In recent years the stock market has mostly done just fine during this period, which hurts our performance on a yearly basis versus the S&P 500 Index. But our strategies are not designed to beat the S&P 500 Index on a yearly basis; instead, they are designed to beat the S&P 500 Index across a full bull/bear cycle (i.e., from bear market low to bear market low and from bull market high to bull market high).

A string of bullish years for the stock market makes it very easy for investors to suffer "recency bias" and to forget/ignore the long-term history. Because this type of thinking is a danger to investors, we would like to shine a bright light on the long-term results. As you may know, our flagship strategy, the Alpha Mid-Cap Power Index Managed Account, holds intermediate-term (3-7 year) U.S. treasuries from the beginning of June into late-October each year. So, for our test this month we will compare monthly total return data for the Bloomberg Barclays U.S. Intermediate Treasury Index versus the most popular stock market benchmark - the S&P 500 Index - for the months of June through October starting in 1981 and going through 2019.

In Figure 2 we see that over the entire 39 years of data, intermediate-term treasuries outperformed the S&P 500 Index by a factor of 2.7-to-1 (+288.6% versus +107%). Of equal significance, particularly when looking at things from a "reward-versus-risk" basis, is the fact that during the Dead Zone months of June through October (when the bulk of stock bear markets tend to occur) the largest drawdown for intermediate treasuries was a meager -2.5% versus -40.8% for the S&P 500 Index. For investors seeking long-term growth of equity AND lower volatility this is a disparity that should not be ignored.

Figure 3 displays in graphic form the magnitude of the drawdowns experienced by both intermediate-term treasuries and the S&P 500 Index during the Dead Zone months. For investors interested in managing risk via an all-weather strategy, the results are quite compelling.

As we move into the year 2020, the U.S. stock market remains in a bullish trend. In fact, a number of broader worldwide indexes are or may soon be joining the party. Investors should continue to enjoy and take advantage of the bullish run to increase their own wealth. But at the same time, investors should not fall into the age-old trap of becoming complacent and assuming that never-ending profits are assured. Because they never are.

Jay Kaeppel
Director of Research

Disclosures and Disclaimers: Past performance is not a guarantee of future performance. The returns illustrated in the charts above do not represent actual trading and are not representative of the returns of any strategy. The illustrations are designed to quantify the effect of certain time periods (as specified) on the Bloomberg Barclays U.S. Intermediate Treasury Index and the S&P 500 Index. Indexes are not investment vehicles and persons cannot invest directly in an index. Index funds and ETFs may vary somewhat from index returns due to management fees and portfolio structure. 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. < br>

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. Before investing in any fund and/or strategy, investors should consider the investment objectives, risks, charges and expenses of the fund/strategy and its investment options.  

Alpha Investment Management, Inc. is a SEC registered investment advisor located in the State of Ohio. 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.  

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