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Buy,Hold, & Hope (why the stock market stinks)

November 17, 2008

 

It has been no secret that stock markets around the world are getting trounced this week/month/year (take your pick), and we thought this as good of a chance as we'll get to kick it while its down. The "market" as it is often referred to as if there were no such things as Corn or Crude Oil markets, is currently at the same levels it was in 1997.

That's 11 years of nothing for anyone who's counting. Imagine if you had plopped down a nice piece of cash on some market investments back in the hay day of 1997 and stuck with the old buy & hold investing mantra this entire time. Ignoring any dividends, you would be right back where you started. Surely not the end of the world, but not exactly the nice 10% annual return investors often feel is their god given right.

The merits of the old fashioned "buy and hold" investment strategy just don't look very good anymore. It took 7 years for stocks as measured by the Dow & S&P 500 to make it back to new highs from the lows made after the internet bubble burst. But what if you were a high tech investor mainly in growth stocks on the Nasdaq.  The Nasdaq will be going on 9 years since its last high mark this coming March, and is 70% below those highs.(talk about a drawdown)

How about Japan? Would you believe it's been nearly 20 years since the Nikkei was at its highest levels. 20 years!! Wow! I would hate to have been a 40-something Japanese investor looking to put some hard earned money to work in hopes of retiring in 20 years back in 1989.

Now, most people aren't investing a lump sum at one point in time and then holding onto it over the years; and thanks to that you can dollar cost average into the stock market to avoid 20+ years without ever seeing the investment be worth more than what you paid for it.

But whether you buy all at once or average in, most investors in America are unwitting proponents of the buy, hold and hope stock market strategy. They are heavily invested in equities (stocks) on a "long term basis", with most of their investable assets in mutual funds and supposedly "blue chip" stocks.

These investors are generally not concerned about the inevitable ups and downs of the market because they rest easy in the knowledge that the market will go up over the "ong term". With their stock brokers and the supposed experts on television preaching that the market "always comes back", they buy 'em, hold 'em, and hope that everything works out all right.

But should hope be part of your investment strategy? How long will it take for the "market" to come back? Would you believe 5 years? 10 years? How about 20 years? What if it wasn't for the rest of your life? Where would that leave you?

Let's look at some data to try and put this buy, hold, and hope strategy into perspective. The table below shows several different periods in the past 100 years during which the Dow Jones Industrial Average took between 5 and 25 years to "recover" its losses.

 

 DJIA Risk Assessment
 PeriodTime to Break-EvenDrawdown
A1907 - 19169 years-48%
B1920 - 19255 years-36%
C1926 - 195425 years-89%
D1965 - 198318 years-37%
E2000 - 20077 years-39%
F2007 - ????1 year & counting-41%
    
  Other Markets 
Nikkei1989 - ????19 years & counting-75%
Nasdaq2000 - ????8 years & counting-71%

The data shows five different periods where the market fell anywhere from 36% to 89%, then required 5 to 25 years to recover the loss. We all have heard about investing for the long term, but 25 years?? That's a little longer than most probably think of long term.

The period from 1962 to 1982 is particularly interesting, as the Dow gained just 43 points (5%) in 20 years. Yes, that works out to just one quarter of one percent return per year. If you think this is a phenomenon of the past, consider the figures in the beginning of this article which pointed out that we are right now exactly where we were in 1997, 11 years ago.

Has anyone ever told you that you may have to wait 5 to 25 years to breakeven on your stock market investments? If they did, would you be a willing investor? I doubt it. But that is exactly what millions are doing with their buy, hold, and hope strategy.

There have been 29 bear markets since 1900 as measured using the DJIA. That's an average of one every 3.5 years. While the average bear market decline was just over 30%, there have been 9 declines that averaged nearly 50%. A buy & hold investor will suffer every bit of those declines and every one of them by definition, as they hold no matter what.

It is also important to note that if and when the index does come back, it may not even contain the same stocks. The major stock indices rebalance their indexes at least once a year, as evidenced by the Dow Jones Industrial Average containing only about half the stocks that were in it 10 years ago, so the stocks in your portfolio may take even longer to get back to break-even, if they ever do at all.

Consider that there is only one company (GE) currently in the Dow Jones Industrial Average which was a component of the index back at its founding in 1896. So the charts you see showing a nicely sloping upwards curve for the stock market as represented by the DJIA over the past 112 years assume you are switching your stock market exposure around just as the index is doing from time to time.

But if I'm just supposed to buy and hold, where does the rebalancing come in. How do I know when to drop the US Leather Co., National Lead Co., & Laclede Gas Light Co.? (all original Dow components which eventually ended up at $0)

It just doesn't follow that if I buy the 30 stocks making up the DJIA today, I will get the same performance as the DJIA over the next 10 years. The powers that be cleverly hide this information from your everyday investor and try as we could, we could not find a chart showing the performance over time of the 1925 DJIA, or the 1985 DJIA, for example; walked forward over time.

We did look at four companies who were in the 1999 DJIA (Eastman Kodak, Philip Morris, International Paper, and Allied Signal), but have since been removed to see what their performance was over that time. Would you believe they lost, on average, -63% of their value, since Nov. 1, 1999. That's quite a different story than the approx. -25% loss the Dow Jones Industrial Average has lost over that time, and shoots some more holes in the old buy and hold strategy. Now you're hoping that not just the index makes it back to break-even, but some of the stocks that were dropped out of it as well.

We are managed futures specialists, so we'll of course tell you that the uncertainty of the Buy, Hold, and Hope strategy is just one more reason to consider managed futures investments for a portion of your portfolio. But even if you don't heed that advice, please heed the warning that the old fashioned buy, hold, & hope strategy is a flawed one.

At best, you may have to hold and hope for a very long time, and at worst (Japan/Nasdaq) you may be hoping stocks come back for an eternity. So don't just hope that the market will turn around. Do something. Review your portfolio, rotate into and out of sectors and companies, and diversify into alternative investments.

- Walter Gallwas

IMPORTANT RISK DISCLOSURE


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Feature | Week In Review: stocks head back towards the October lows | Chart of the Week

***Overview***

After a brief respite to the upside a few weeks ago, global stock markets headed back down to their lows last week. The bad news was not confined to the U.S. as the 15 European Union countries that use the Euro currency announced a second straight quarter of contracting growth. Headlines from other continents also indicated a weaker economic tone which furthered ideas that global consumption and purchasing of all products will be reduced greatly from earlier expectations. The evidence hit the Stock Index sector the greatest and was especially hard on small caps with the Russell futures -12.34%, and the Mid-Cap shed -10.45%. The large caps were led by the tech heavy NASDAQ falling -10.43%, followed by S&P 500 futures -7.98% and the Dow futures lost -6.95%.

Energy futures were also a victim of the worsening world economic news as not even talk from OPEC of further production cuts could strike support. Normal seasonal usage factors with winter coming in the Northern Hemisphere also failed to produce support. For the week RBOB Gas shed -8.29%, Heating Oil fell -7.52%, Natural Gas ended -6.69% lower and Crude Oil lost -6.66%.

Activity in the Metals during the past week was mixed as hard asset buying supported the Gold +1.22% and news of higher Chinese imports sparked enough support in Copper to eek out a slightly higher close. Recessionary fears kept the balance of the complex under the weather as Silver lost -3.32%, Palladium shed -2.39% and Platinum ended with slight losses.

Currencies remained in a mixed state during the past week as it seemed the unwinding of the U.S. Dollar and Japanese Yen carry trades came back to the forefront, especially with another round of gloomy economic forecasts. The Japanese Yen +1.32% was the strongest of the two with the U.S. Dollar ending slightly higher. British Pound ended -5.70% , Swiss Franc lost -1.48%, and the Euro shed -1.01% on ideas of further European rate cuts in the near future. U.S. Rate futures found support from safe haven buying despite signs that the credit freeze might be worsening again as the Libor upticked last week. 30-year Bond futures ended up +1.85% and 10-year Notes futures gained +1.19%.

Commodity and food price activity was mixed last week as demand help sparked gains in some sectors, although poor economic reports kept others heading lower. Wheat +6.01% found support on news of export purchases and weather issues which in turn supported Corn +1.42%. It was nice to see these grain markets decouple from stock price direction for a week at least, but Soybeans -2.82% were the exception. The soft sector was mixed as OJ lost -4.26%, Sugar was down -2.99%, Cotton fell -2.58% and Coffee ended -1.13% lower. Cocoa +5.19% on seasonal buying and weather worries.

 

***CTAs***

Multi-Market managers continue to do well despite the volatile trading conditions across nearly all market sectors.  In stock index trading the $VIX.X (CBOE investor fear index) remains near record highs as investors continue to flee stocks to historical “safe haven” type investments like US Treasury Bills and precious metals.  However, some managers and trading systems are beginning to take long positions as technical indicators also show that stock index futures may have at least reached a short term bottom.  Long treasury future positions are also popular across trend following programs as many multi market managers expect worldwide interest rates to continue to move lower. Finally, short term trades in energies and grains have proven successful as well due to the large moves these markets are seeing on a daily basis.

Thus far in November the Attain Portfolio Advisors Strategic Diversification Program +3.33% est and APA Modified Program +2.49% est continue to do well with most profitable trades coming from the stock index, metals and treasury sectors.  Clarke Capital has also started November strong with returns of +2.22% est in the Global Magnum program and +2.09% est in the Global Basic program.  Last but not least Hoffman Asset Management is also doing very well with returns of +1.93% est this month.

On the downside DMH -0.75% est, Robinson Langley Capital Management -1.17% est and Dighton USA Swiss futures -3.44% est, have pulled back slightly this month.  All three programs had posted strong returns in October but have given some back after two weeks of trading this month.  Thankfully there is still plenty of time for these managers to make a comeback before month end.

Finally, both Longtermtrading.com Navigator and Northside Trading are at breakeven for the month.

In the Option markets, this past week saw virtually no change from the week prior as most mangers continue to remain cautious and/or out of the market entirely.  November MTD estimates are as follows: Ace Investment Strategist -13.13%, Cervino Diversified +0.16%, Cervino Diversified 2x +1.47%, Crescent Bay PSI -2.29%, Crescent Bay BVP -3.23%, FCI +1.53%, Rathiel -1.48%, and Zenith is unchanged with no trading in November.

Agriculture traders also held steady last week with limited movement in accounts managed by Rosetta and NDX Capital.  NDX is currently hovering between 0% and -0.5% for their two programs (Abednego and Shadrach).  Rosetta on the other hand is down aprox 7% for the month after exiting a losing Hog spread in the first week of the month.  For fundamental traders the opportunities in the months ahead could be historic as many of the current futures prices are trading at deep discounts to the actual cash market prices...this point is interesting as futures and cash must come to "parity" at some point in the future creating an opportunity for managers like Rosetta and NDX.

 

***Trading Systems***

The retest of the recent lows in global equities set the stage for an ideal trading environment for trading systems on many different time frames. One of the unique aspects of trading futures is the ability to capitalize in rising or falling markets, particularly during times of increased volatility.

Beginning with the day trading programs, Rayo Plus Dax continues to impress +$9,936.57 for the week. This program is extremely volatile on a day to day basis, but has paid off those patient investors who have been able to stomach the swings. Waugh eRL finished the week +$2,345 thanks to a huge winning trade on Thursday when U.S. equities turned on a dime late in the afternoon to finish sharply higher. Rounding out the other two winning day traders, BetaCon 4/1 ESX was +$59.77 on two trades early in the week. On the losing side, Compass SP dropped -$4,979.50 on three short trades and will look to bounce back this week.

Moving on to the swing programs, Jaws US 400 made +$796.40 on a long trade early in the week, then re-entered long on Friday and held that position heading into the weekend. Mesa Notes reversed its position in the Ten Yr Notes for a gain of +$3,728.13 on the closed out portion of the trade.

In long-term multi-market trading, there was limited activity either entering or exiting existing positions. Most programs continue to hold short equity futures positions, and that paid off as global equities headed lower throughout the week. Bonds of all durations have perked back up after selling off alongside equities on the first leg down a few weeks ago, triggering some long entries in the Five Year and Ten Year Notes, as well as in some of the foreign equivalents like the Euro Bund, Bobl, Schatz and Long Gilt.

IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.

Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.

Please read carefully the CFTC required disclaimer regarding hypothetical results below.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.