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Printer Friendly View (with text zoom)BEING STREET SMART by Sy Harding CAN CORRECTIONS BE BETTER THAN RALLIES? February 5, 2010. Twenty years ago, just prior to the 1990 recession, I wrote a
little booklet for my subscribers which I titled ‘Bear Markets Are Best’. Its
premise was not that bear markets are really better than bull markets, but that
they are not something to be feared, and do have some advantages over bull
markets. The same goes for intermediate-term corrections within bull markets. For instance, if you position for them in a reasonably timely
manner, not just by moving to cash to avoid losses, but to downside positions
that go up when the market goes down, the profits can come faster than they do
in rallies and bull markets. That’s because the market moves down much faster in
corrections than it moves up in rallies. For instance, in the 1990 bear market the S&P 500 lost the
gains of the previous 15 months in just four months of decline. An investor
playing the downside could have made at least some portion of 15 months of gains
in just four months, rather than giving back 15 months of gains. In the 1987
bear market the S&P 500 lost the gains of the previous 18 months in just three
months. In the 2000-2002 bear market it lost the previous four years of gains in
two and half years. In the recent 2007-2009 bear market it lost its previous
five years of gains in just 17 months. At the present time, since its peak on January 19, just over
two weeks ago, the S&P has lost all its gains of the previous three months,
closing Thursday at its level of November 5. It is an important lesson not just for buy and hold
investors, but for all investors. When market declines take place, if no action
is taken previous gains can be given back much quicker than they were made. Just
avoiding at least some of the decline is advantageous to long-term investing
performance. If even partial downside positioning is taken in time, further
gains can actually be made from the market decline. In the ‘old days’ prior to the introduction of bear-type
mutual funds, and the more recent introduction of ‘inverse’ mutual funds and
‘inverse’ etf’s, investors could only take advantage of market corrections to
avoid large losses, and then make some of the profits all over again by getting
back in at lower prices. Even that strategy produced significant market-beating
performances. In 1986 Norman Fosbach included a study in his book Market
Logic covering the period from 1964-1984, in which he found that an investor
starting with $100,000 in 1964 would have produced a gain of $775,000 over the
20-year period on a buy and hold basis, using the S&P 500 as the proxy. That’s a
substantial gain. However, his study found that if an investor could have timed
only the major market swings over the period he would have turned the $100,000
into $13,810,000 over the same period. And timing only successfully enough to
avoid the three worst downturns of that 20-year period would have turned
$100,000 into $4,797,000, almost six times as much as the market made on a buy
and hold basis. In fact, Fosbach’s study found that any degree of success at
all in avoiding even a portion of downdrafts had a tremendous effect on
long-term accumulation of wealth. His
study showed that if one recognized a correction was underway only perceptively
enough to sell short for only one-fourth of each of the three worst corrections
during the twenty-year period, and remained invested through all the rest of the
downturns, he still would have tripled the return of a buy and hold strategy. I haven’t run the numbers, but given the market’s periodic
give-back of previous gains over the last twenty years, which I noted at the top
of the column, it seems obvious that it has been the same situation for the last
20 years. Avoiding the major portion of the big losses, or even better, to make
additional gains from downside positions during at least portions of big
declines, can make a major contribution to long-term investing success. Given the market’s action of the last two weeks it might be
something investors would do well to study up on.
Sy
Harding is president of Asset Management Research Corp, publishers of the
financial website StreetSmartReport.com; the Street Smart Long and Short Stock
Advisor; and a free daily market blog at
www.StreetSmartPost.com. These reports reflect our opinions and are based on our best judgment, but no warranty is given or implied as to their accuracy. Past performance does not guarantee future performance. Back to the Top Home Forward to a Friend >>>
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