Over the past 18 months the global stock market has moved lower by 1.4%(i). It gained in 2014, only to lose those gains and more over the past 5 months. Up, down, up, down. What is going on? Investors may look at this activity and question the validity of their investment strategy. Why can’t their investment portfolio produce a reasonable return without the back track? Faced with an illogical market, who can we look to for help? What is the logical thing to do? As a child of the 60s, I always look to Star Trek for guidance. And no one was more logical that Mr. Spock. What would Mr. Spock do under similar circumstances? Would he sell his portfolio to invest in his brother’s dilithium crystals mine? No he would not. Instead, our Vulcan guide would look at similar historical declines and ask: what does the data tell us is likely to happen when the stock market makes sideways moves for extended periods?
Long periods of low or no returns are one of the most difficult behavioral challenges that investors confront. However, as it turns out, these periods very common and are predictive of future gains. There is a one in four chance that any 3 year period in the stock market will produce returns of less than 3% per year. On average when this happens, however, it is followed by a surge higher of 37%, or just over 11% per year over the following three years(ii).
What about five year periods when the stock market moves up, down, and sideways and earns less than 3% per year? Investors have a strong proclivity to abandon their investment plans after such drawn out periods of stagnant growth, but the rally following make that appear unwise, as stocks gain an average of 80% over the ensuing five years. We’ve found it useful to employ the image of a spring being compressed when thinking about stagnant markets. As sideways markets extend longer, the spring is compressed further. Eventually, history suggests that the spring will vault portfolios higher. That is, of course, unless you sell your portfolio to invest in your brother’s dilithium crystals mine, which may have mixed results. By looking carefully at the data around sideways markets and making contemplative, analysis based, decisions, you are able to invoke your inner Spock, and potentially grow your
portfolios too.
Worried About the Recent Decline? Don’t Be…
We built our strategy with the assumption that markets would experience declines, even significant declines. When markets begin to move lower, our system attempts to detect the early stage of a decline and exits to money markets or other defensive positions. If markets continue to lose value, our re-entry price dials lower too, possibly creating an opportunity to re-enter at better values and participate in the following rebound that may occur. That’s exactly what has played out over the past quarter. Toews began the quarter already defensive in our High Yield Bond positions. In mid-July, we exited International Stocks and we completed our exit out of US Stocks in late August. Especially in the case of High Yield Bonds and International Stocks, where our exits occurred earlier, we avoided sizable moves lower. However, and more importantly, our portfolios are positioned to potentially protect us from further declines if market losses continue.
Market Environment
Stock valuations are driven largely by growing company’s earnings. Yet recently, earnings of many companies, both US and International, have been moving lower. Current predictions are that S&P 500 company’s earnings will decline by 5.1%iii this quarter. If this holds true, it will be the first back to back quarter of earnings declines since 2009.
Yet, the S&P is currently valuing stocks highly, at just under 20 times trailing earningsiv. That’s well above the average of 15.5 times earnings. We don’t know if the recent trend for earnings will continue. But if they do, it virtually guarantees that the decline that picked up during the last quarter will accelerate. As we are currently fully defensive across our platform, we would hope to continue to avoid losses from additional declines. However, if the markets for whatever reason turn higher, we’re poised to react and re-enter to potentially to capture any year-end gains.
The path to navigate these markets and address possible significant declines is straightforward but requires constant vigilance: 1) stay committed to equity markets, historically the best performing asset class to help protect against inflation and 2) hedge your portfolios against losses. Both are pillars on which the Toews system is built.
Live long and prosper!
Phil Toews
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. For a complete list of GIPS firm composites, their performance results and their descriptions, as well as additional information regarding policies for calculating and reporting returns, please go to www.toewscorp.com. Toews Corporation acts as the investment advisor that implements the asset allocation and models for each of the portfolios. Investors cannot invest directly in an index.
(i) Based on the return of the MSCI World Total Return Index – Net. Source: MSCI.com
(ii) Source: Global Financial Data. Based on S&P 500 returns from 1800 through 2014