Stocks and bonds were a mixed bag in the third quarter. The S&P 500 increased 1.1%(i) for the quarter while other asset classes fared poorer. The MSCI EAFE (International) Stock index lost 6.4%, the Russell 2000 was down a painful 7.36%, and the Merrill Lynch High Yield Bond index declined 1.9%. Inflation protected bonds were also down.
Toews began the quarter fully invested across all asset classes. In early August, we exited International Developed Stocks, followed by an exit from Emerging Markets in September. At the end of the September, our equity portfolios held only US stocks, with all other assets in a defensive position in cash or short term bonds.
Our Dynamic Fixed Income models that invest in High Yield and Aggregate Bonds also moved to a protective stance during the quarter. The decline in High Yield bonds picked up steam in late September, a move that Toews largely avoided.
Stock Market Psychological Tug-of-War
As the market pushes higher and the duration of the advances lengthen, investors’ desire to lower risk diminishes. Recency Bias causes investors to conclude “the market has moved higher for 6 years, it will probably continue to move higher.” Of course, just the opposite is true. As rising markets peak, the probability of large declines increases. This psychological tug-of-war has vexed investors for centuries.
Investor Psychology during Market Advances
The longest stock advance in the past century was the bull market of the 1990’s, lasting just over 12 years. We remember it well, as we were managing our same risk-lowering portfolios during that time. Stocks peaked on March 24, 2000, marking the end of the internet bubble. In the years leading up to that market top, flows into stocks (especially growth and internet stocks) were extreme. Strategies to avoid risk were abandoned when they were most needed. We all know the outcome of that bubble. It was followed by two separate 50% S&P 500 declines in a bear market that lasted over a decade, doing immeasurable damage to investor portfolios.
Investor Pre-Commitments Lead to Improved Outcomes
So how can investors avoid being tugged by markets into high risk portfolios at the wrong time? Advisors that recommend Toews portfolios have for several years been using the tool of Investor Pre-Commitments to help guide investors toward decisions that can be counter-intuitive. During long term rising markets, when risk managed portfolios tend to lag markets, the Pre-Commitment is to rebalance from un-protected positions into risk managed strategies in order to maintain the desired level of portfolio insurance.
Investor Pre-Commitment during Rising Markets
To help avoid the natural psychological pressures created by the market, we’ve built a cheat sheet of the several biggest behavioral challenges faced by investors, along with recommended pre-commitments, that follows this commentary. The next time that the markets make you feel uneasy, refer to this sheet, as it may clarify the path forward.
Toews Exits US Stocks in Early October
Earlier this month we exited US Stocks and became fully defensive across our platform. October has historically been a month that can produce huge declines. Both the 1929 and the 1987 crashes occurred in October. Are we predicting a crash? No. However, if the markets continue to move lower, we will happily sit on the sidelines.
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.
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) Source: All performance from Morningstar, Inc.