Allocation Strategy

The Smart Bird: Counting the Days

S&P 500 index

S&P 500 index

The S&P 500 is currently bouncing between support and resistance.  Market internals are giving no clues as to the direction of the market.  So as we wait on the market to digest investor expectations, I decided to continue to compare the current situation with market history.  I was reading Dr. Yardeni’s blog about the number of days from market highs to correction lows and I decided to investigate some more.   Dr. Yardeni presented the following chart.

Days for Dips

Instead of looking at the number of days from market highs to lows as Dr. Yardeni, I looked at the number of days from when the S&P 500 index first broke support to the final lows of three market corrections.  Dr. Yardeni defines dips as declines of less than 10%, corrections as declines of between 10 – 20%, and bear markets as declines of greater than 20%.

I looked at the last three corrections within bull markets: 1998, 2010, 2011.   Since we only have three data points, we can not make an academic study of this.  But all three cases were in the ball park of 40 trading days from when the market broke support until its final low.  All three had at least one good bounce.

So what day are we currently in this correction?  September 2nd was the 10th trading day.  We have 30 more trading days according my highly in-depth analysis of three data points.   That would place the correction’s bottom right in the middle of October.  October 15th is the 40th trading day.  Hmm.

October is known for its significant down days that end market corrections and start the beginning of rallies extending into the strongest months of the year for equities (end of October – December).  One of the reasons the late October to December time frame has such a good track record is that it often starts from a summer correction low that ends in fall.  In other words, this period includes the bounce back rallies.

I did not connect these dots before I started this little drill.  My original take-away was simply to be prepared for continued volatility and the likelihood we would see another low in the future before we see a solid rally.  How strong of a rally depends on the larger question of whether we are still in a bull market or beginning a bear market.   The seasonal connection came during this little research project and leads me to another short discussion on the market’s seasonal tendencies.

A prospective member asked if my strategy of investing only in the favorable season for equities also had drawdowns (declines).  The answer of course is yes, but his implied question was on the magnitude of the corrections.  I produced the following charts to compare the drawdowns of two investors.  The left chart shows the drawdowns for a buy & hold investor and the right chart shows the drawdowns for an investor if they followed our strategy of only investing in the favorable season for equities.

Drawdown Compare

The charts only show the drawdowns from new highs and explain why the Ulcer Index (yes it is a real index) is lower for the seasonal strategy.   I had to compress the seasonal chart to align the percentage drawdowns since software adjusted the percentage scale based on the results.  The time frames are the same (1954-2014), but as you see the losses and stress of investing are much lower for the seasonal investor.  The returns are also significantly higher for the seasonal investor over this period – the reason I adopted and optimized them for the TSP funds.

The best strategy for navigating deep market corrections is to avoid them in the first place.  While following a seasonal strategy eliminates most of the major declines, you will still experience declines.  Most of these declines come in bear markets which is why my other focus is on avoiding times of elevated risk observed prior to significant market corrections and bear markets.  And this is what I mean when I say, Invest Smart.

 

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