Breaking Markets – The Bear Awakens

From last week:

 “Over the last couple of months, I have repeatedly discussed the deterioration of market breadth, momentum and the fundamental backdrop of the markets.

Read the following posts to catch up:

>> Signs Of A Technical Top

>> Signs Of A Fundamental Top

Along with these warnings, I have continually suggested a health regimen of portfolio rebalancing, profit taking and risk controls in this weekly missive: To wit:

• Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
• Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
• Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low 

As I have discussed many times in the past, the trend of the market is still positive and there is no reason to become extremely defensive as of yet. However, this does not mean to become complacent in your portfolio management practices either.”

It is that last paragraph that I want to focus on with you today.

No Bull, No Bear

Let me clarify something before I go further into this week’s missive.

In the media, and on Wall Street, there is an overwhelming push to classify views as either bullish or bearish. This is a VERY dangerous thing for investors.

The reason I say this is that since, in the words of Bob Farrell, “bull markets are more fun than bear markets,”investors tend to seek out “bullish” commentary to support their “hopes” of a continually rising bull market. The danger, as I have addressed in the past, is that individuals become “willfully blinded” to data that does not conform to their personal biases. This bias of seeking out only “confirming data,” known as confirmation bias, leads to decision making that is ultimately prone to error.

While I am personally tagged as a “bear” because I discuss not so optimistic views of the market and point out inherent risk, I assure you I am NOT a bear. I am also NOT a bull. I simply look at the relevant data and make determinations of risk based on historical precedents and statistical data.

As a portfolio manager of OTHER PEOPLE’S money, my biggest concern is not how much money I can make during market advances, but rather how much I keep from losing during market declines. While this seems counter-intuitive, it reality it is where long-term gains are actually generated. As William Lippman once quipped:

“Better to preserve capital on the downside rather than outperform on the upside”

However, it is this focus on capital conservation and risk management that gets me habitually tagged as a “bear.” If that is the case, so be it – I will gladly wear that moniker if that leads to better outcomes for those I work for. 

The reason, I say this is because it simply comes down to the math.  As I wrote last week:

“The reason that portfolio risk management is so crucial is that it is not “missing the 10-best days” that is important, it is “missing the 10-worst days.” The chart below shows the comparison of $100,000 invested in the S&P 500 Index (log scale base 2) and the return when adjusted for missing the 10 best and worst days.”

“Clearly, avoiding major draw-downs in the market is key to long-term investment success. If I am not spending the bulk of my time making up previous losses in my portfolio, I spend more time compounding my invested dollars towards my long-term goals.”

Let me reiterate this point. A strict discipline of portfolio risk management will NOT eliminate all losses in portfolios. However, it will minimize the capital destruction to a level that can be dealt with logically, rather than emotionally.

In the end, it does not matter IF you are “bullish” or “bearish.”The reality is that both “bulls” and “bears” will be owned by the full-market cycle. However, what is grossly important in achieving long-term investment success is not necessarily being “right” during the first half of the cycle, but by not being “wrong” during the second half.

The Bullish Trend Is Broken

Investing is really pretty basic and defined by two simple rules as defined by Dennis Gartman:

“In bull markets we can only be long or neutral, and in bear markets, we can only be short or neutral. That may seem self-evident; it is not, however.”