Ciovacco Capital Management, LLC (CCM) has a blog called Short Takes which offered an interesting piece lately that I think is important, asking what are “The Two Most Important Questions For Investors?”
The piece caught my eye because it echoed my last quarterly commentary and my current view, here are some excerpts from the post.
Many investors toss and turn at night worrying about wealth-destroying bear markets or opportunities they may miss for their uninvested cash, which is nature’s way of pointing out vulnerabilities. When testing your current approach to the markets, it is helpful to look at extreme outcomes. If you can handle the extremes, then you can handle almost anything in between. Therefore, this weekend ask yourself:
Do I have specific plans in place to handle these extreme investment cases?
Case A: stocks rise an additional 91% over the next three years as they did during the final leg of the dot-com bubble (1997-2000).
Case B: stocks drop over 50% as they did in the 2000-2002 and 2007-2009 bear markets.
Of course we might be in a market that ends differently than these two cases (such as a flat market for years to come), but given the current valuation levels relative to history, there is evidence to the contrary. Here is what CCM says:
How could stocks possibly rise 91% between 2014 and 2016 with valuations already stretched? That is a rational question and one that was being asked in 1997. From a contingency planning perspective, it is best to always keep an open mind about upside and downside potential. The S&P 500’s recent breakout from a 13-year consolidation pattern, described here, is another reason to keep an open mind about hard-to-comprehend gains.
During a bear market, investors start to believe that stocks will never go up again. Conversely, the longer a bull market lasts, the harder it is to comprehend that a bear market will come at some point. When the next bear market begins is highly uncertain, but we know with 100% certainty that another bear market will eventually rear its ugly head. If we know a bear market is in our investment future, it is prudent to have specific plans in place.
CCM goes on to show how either the gain or loss would affect your portfolio:
CCM goes on to use some technical analysis to determine how best to position yourself, but I think the above to charts are the important ones. Is missing out on a portion of the potential upside a better outcome than experiencing a substantial portion of the downside? This is the question that should be primary in your thought process right now.
Scott Dauenhauer, CFP, MPAS, AIF