Alpha Power Investing NewsletterAugust 3, 2017
Looking "Under the Hood" at the Dead Zone
The stock market based investment strategies offered by Alpha Investment Management typically avoid the stock market during what we refer to as the "Dead Zone", which extends from the end of May into late October. One question we occasionally get is, "Why do you think the stock market will decline this year between June and October?" The truth is that we don't make any predictions at all. We simply recognize that, a) no one can really predict when the market will bottom out or reach a top, but also that, b) the stock market has a long history of experiencing significant - and occasionally devastating - declines during the June through October period.
Oftentimes these June through October declines are the kind of occurrence that causes traders to not only suffer serious declines in their account equity - which then has to be regained by subsequent market gains - but which also can trigger investors to lose confidence at exactly the wrong moment. This often leads to an investor becoming far too conservative going forward, which can result in vastly inferior long-term returns. In a nutshell, by occasionally sidestepping a significant market decline an investor can, a) compound his or her money at a far higher rate over time, and b) potentially sleep better at night. It is for these reasons that we hold low volatility intermediate-term treasury bonds during the Dead Zone.
A Closer Look at Stocks and Bonds in the Dead Zone
During the Dead Zone period since 1981, intermediate-term treasury bonds have showed a gain 33 times in 36 years. Interestingly, during the same period the S&P 500 Index has also typically showed a gain - with 28 years up during the Dead Zone and only 8 years down. However, in the long run it's not the "number" of winners and losers that matters as much as it is the "size" of those winners and losers. Despite the fact that both intermediate-term treasuries and the S&P 500 Index have mostly showed gains during the Dead Zone, as you can see in Figure 1, the cumulative gain for bonds is +280% versus only a +71% gain for the S&P 500 Index - a difference of almost 4-to-1.
How can this be? Let's take a closer look.
Figure 2 displays the year-by-year percentage gain/loss for the S&P 500 Index during the "Dead Zone" since 1981. As you can see, in fact the majority of years show a gain. Unfortunately for buy-and-hold stock market investors, five of the eight down years registered losses in excess of -12%, including three of -15% or more. These are the kinds of declines that can devastate long-term returns.
Another way to look at the data is to subtract the gain or loss for the S&P 500 Index during the Dead Zone from the gain or loss of intermediate-term treasury bonds since 1981. When we do this we find some interesting results. In terms of raw comparisons, the results are almost 50/50 (bonds have outperformed 17 times, the S&P 500 Index 19 times). Yet despite this split, bonds have vastly outperformed on a cumulative basis. What we see in Figure 3 is that the S&P 500 may outperform for a series of years, but then a year or two comes along where bonds vastly outperform.
Both intermediate-term treasury bonds and the S&P 500 Index tend to register gains during the Dead Zone period between the end of May and the end of October. The key difference is the well-established long-term tendency for the stock market to occasionally register large losses during the Dead Zone period, which in turn can have a very damaging effect on long-term returns not to mention the effect on investors' psyche.
What will transpire in the months ahead is unknowable, but given the historical trend we have just discussed we are content to "keep our powder dry".
To learn more about our strategies, go to the Strategies and Performance page of our website at www.alphaim.net to read the brochures and fact sheets.
Disclosures: Past performance is not a guarantee of future performance. Indexes are not investment vehicles. The returns illustrated above are not returns of any Alpha strategy and do not include management fees or the cost of funds, trading, or other expenses. To see the impact of these costs, please refer to the net of fees and expenses performance data for specific Alpha strategies. The illustrations above are designed to quantify the effect of certain time periods on representative market indexes.
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.
© 2017 Alpha Investment Management, Inc.
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