Markets Finish the Year Higher in the Face of Uncertainties

“Sometimes, what matters is not so much how low the odds are that circumstances would turn negative, what matters more is what the consequences would be if that happens.”
Jean Marie Eveillard

Markets Finish the Year Higher in the Face of Uncertainties

Does the debt situation in Europe continue to threaten global growth? Yes.
Is unemployment still higher than during any post-war recession recovery? Yes.
Do we have a dysfunctional legislature and massive government debt? Yes.
Did all of this keep the stock market from advancing 16% in 2012? No.

Since 2009, investors have avoided the stock market and bet on more stable investments. Those that did missed out on the best returning US stock market in the past 3 years during 2012, with the S&P 500 advancing 16%.

For the quarter, the S&P held steady with a slight loss of .4%. Toews systems exited assets briefly during a decline that began in October, but finished the quarter fully invested across all asset classes except US stocks, where we were 2/3 invested.

During the year, the Toews system made several trades out of the market. However, the system was fully invested during the greater part of the year, allowing our portfolios to produce across-the-board gains during 2012.

Throughout the year we’ve expressed extreme caution due to global macro-economic challenges. Our system, however, is driven by market trends. If stocks trend higher, our system reacts and invests, even though economic data is unnerving. Perhaps the biggest value we add to investors and advisors is the ability to follow trends and ignore sometimes distortive news.

Addressing our Biggest Behavioral Investing Challenges

Several days before the end of the year, one investor called in to move his investments out of the stock market and into money market funds. The concern: the dreaded Fiscal Cliff. In the first two days after this investor moved to cash the stock market advanced…4% (gulp)! As we noted at the beginning of this commentary, many factors are causing investors alarm about the economy and distracting them from their commitment to their plans. The temptation to make portfolio changes like this are pervasive in the investing community, and dramatically impair investors’ prosperity.

In 2012, Toews launched a workshop series devoted to helping advisors and their investors address some of the most common behavioral investing challenges. In the workshop, we recommend specific steps for investors to address these challenges, both before they occur, and while they are playing out. We’ve identified the five greatest market challenges to investors as:

We view each of these market challenges as not just possible, but likely if an investor has a long-term investing horizon. We recommend a simple two-step process to help navigate these events:

1. Build portfolios that minimize the effects of each market challenge and
2. Decide on a course of action when each market event occurs and make pre-commitments to execute this plan

Let’s consider the first challenge – when investors face significant losses – and we’ll address the others in upcoming commentaries. When markets produce large losses, a possibility that investors are acutely aware of with losses of over 50% on two separate occasions during the past 13 years, it presents a considerable obstacle to good investment behavior. Most envision the challenge as sticking with the market during the short-term period when the market is falling. We recognize that as a challenge, too, but we are also aware of an even greater challenge that we refer to as a stock market “super-cycle”.

The following chart shows stocks increased 1167% after inflation between 1981and 1999. During that 19-year period investors “learned” that stocks almost always move higher. Investors also tended to think of short-term losses as buying opportunities rather than events to be feared. Just as investors became certain that stocks were the best way to invest, everything changed, and we entered into the secular bear market that continues today. During the past 13 years, stocks have experienced two big drops and have produced a net loss of 9% after the effects of inflation. These long-term “super-cycles” do more than just test investors during moments of market stress; they change investor perspective. It changes their perceptions about the value of an asset class, such as stocks, as an investment, resulting in changes in their investment behavior toward that asset class.

More and more investors now view stocks as risky and poor investments and, as alluded to earlier, have shed exposure to equities in favor of more stable investments. If the markets make another significant move lower in the coming years, we anticipate that the perspective that stocks are poor investments will become even stronger and investors will increase the pace at which they are moving into bonds or other more secure investments just as the stage is set for an explosive stock market rally. The cost of this move to investors would likely be massive. At the end of each secular bear market, stocks made dramatic moves higher. Since 1915, the average S&P secular bull market produced gains of 1100%, even after taking into account inflation. The key, it turns out, is building a strategy that allows investors the ability to endure market declines and stay invested in stocks even through long-term declining markets.

Our Recommendations During and after Significant Declines

1. The first step in our two-step process to address significant declines is to build portfolios that minimize the effects of these declines. Toews portfolios are designed to participate in gains, but also to protect against extreme market crises.
2. The second step, deciding on a course of action when each market event occurs, follows logically from the discussion above. After significant market moves lower, or even a bear market super cycle, it’s imperative to maintain exposure to stocks to participate in the coming market rally. A summary of potential investor choices after market declines is noted below:

Toews Dynamic Hedging during Declining Markets

Although the outlook for the stock market can at times be dire, we remain cautiously optimistic. The crucial advantage of our methodology is its ability to attempt to avoid the bulk of market declines. If this is achieved successfully, it creates an opportunity to buy near market lows and participate in rebounds. As a result, it may be possible to produce positive returns even when the market is losing money or moving sideways.
Secular bear markets include not just large drops, but sizable stock market rallies. During the Great Depression, the stock market was in various stages of decline from 1929 through 1942. Despite the decidedly negative bias of the market, the Dow Jones Industrial Average experienced 7 bull markets with returns producing average gains of 54%, lasting on average 7.5 months. Systems that successfully avoid big declines can provide decent returns for investors if they participate in even a portion of these robust market rallies.
The path to navigate these markets and address possible significant declines is straightforward but requires constant vigilance: 1) stay committed to equity markets, the best performing asset class that helps protect investors against inflation; and 2) hedge your equity portfolios against losses. Both are pillars on which the Toews system is built.

Disclosure

Prior performance is no guarantee of future results. There can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance. There can be no assurance that Toews will achieve its performance objectives.

This commentary may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

This commentary is intended to provide general information only and should not be construed as an offer of specifically-tailored individualized advice. Please contact your investment adviser, accountant, and/or attorney for advice appropriate to your specific situation.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent to you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

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