In our last quarterly commentary, we discussed how difficult predicting recessions is, even for professionals. That was the case for the fourth quarter as markets and the economy stretched higher despite an inverted yield curve1, a lower September U.S. Manufacturing Purchase Managers Index2, and a drop in Consumer Sentiment in August3.
Why? In our view, markets advanced because the Federal Reserve decreased rates at the last three consecutive meetings. Also bolstering market sentiment was the progress made toward a phase one agreement to reduce tariffs between the US and China. Yet, operating earnings in the U.S. actually declined in the 3rd quarter, and appear to be on pace for muted gains or small losses in the fourth quarter. This has increased valuations to high levels from a historical perspective, and valuations can be a factor in predicting future long-term returns.
Maintaining the Course in the Face of Adversity
Investors that left the markets last year due to the seemingly relentless negative news on trade and the economy likely have regret about missing out on recent gains. Looking into the new year, stocks and high yield bonds may be positioned for further advances. Because real yields on cash are close to zero, investors seeking growth are currently forced to move into riskier classes of financial assets if they want to see decent gains. Yet, historically, high valuations may be a factor in predicting lower gains ahead or even losses if the economy turns lower.
A climate of heightened risk in a strongly trending bull market is among the most difficult climates for investors to navigate. Market direction over the short term can defy logic. The key is to position portfolios to attempt to participate in market gains, but also potentially address market downturns. As markets stretch further into overvalued territory, the probability of declines may increase until it becomes seemingly inevitable. Our algorithms favor strong trends and even welcome periods of excess, potentially allowing our investors to participate in rising markets before markets turn lower.
Key Characteristics of Toews Tactical Models
1. Attempt to exit markets early, before negative momentum builds
Our initial research on market declines revealed that some declines may begin slowly with little momentum and small percentages losses. Over time, negative momentum builds, causing larger percentage declines, potentially culminating in a market crash. The key for tactical strategies is to attempt to move to a defensive posture in the early stages of declines before negative momentum builds.
Strategies that move defensive more slowly may appear desirable during bull markets because they exit fewer times and may realize a bigger share of gains. A downside to a slow-moving algorithm, however, may be that if the market enters free-fall faster than a manager moves defensive, the algorithm could signal an exit after a decline has already occurred. As can be seen from the 1987 crash, declines can happen very quickly.
Some of our models have been tested through many types of markets over the past two decades and are designed to attempt to move defensive in the early stages of declines, before negative momentum leads to larger declines.
2. We React to Prices Instead of Attempting to Predict Market Direction
At Toews, we don’t depend on market predictions as a part of our process. Instead, our systems monitor asset prices and attempt to move to a defensive position during the initial stages of declines. In other words, our trades are based on the price movements of the market.
Because market moves over the short term are sometimes inexplicable, as they have been over the past year, our price-reactive trading model reduces the subjectivity in our trading and may allow us to participate in market trends4. The algorithms we developed in the 1990’s, which we used to address market moves then, are still being used to manage portfolios for our clients today.
Over the coming year, it is highly likely that news at times will cause investors anxiety. Remember, however, that at Toews, we have a plan in place to attempt to address falling markets.
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.
Investors cannot invest directly in an index. The S&P 500 Index is a market value weighted index and one of the common benchmarks for the U.S. stock market.
For additional information about Toews, including fees and services, send for our disclosure statement as set forth on Form ADV by contacting Toews at Toews Corporation, 1750 Zion Road, Suite 201, Northfield, NJ 08225-1844 or (877) 863-9726.
(1) Source: https://fred.stlouisfed.org/series/T10Y2Y; Date Accessed 1-9-2020
(2) Source: https://www.bloomberg.com/news/articles/2019-09-23/u-s-ihs-markit-services-employment-gauge-dips-into-contraction; Date Accessed 1-9-2020
(3) Source: https://data.sca.isr.umich.edu/fetchdoc.php?docid=63703; Date Accessed 01-09-2020.
(4) Some Toews models may invest in an options overlay and/or in an aggregate bond strategy, which may function differently than the main strategy which is price-reactive.