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The near term is going to be all about the Fed and what they say about tapering their bond buying. In anticipation the market has rallied from the low it set on June 5th. Markets were oversold but they also seem to be interpreting the Fed’s message as QE is somewhat irrelevant because they will maintain a zero interest rate policy until the unemployment rate hits 6.5%, which isn’t going to happen anytime soon. It also looks like the market doesn’t mind talk about Ben Bernanke leaving in January as he would probably be replaced by Janet Yellin who seems to espouse all the same ideas.
We sold our counter trend positions in the S&P 500 in our Trend Aggregation Strategies into yesterdays rally as the market looks slightly overbought in the short term.. This brings our cash positions in the Trend Aggregation Strategies around 50% across the board. Our Momentum Strategies are still fully invested.
We Know What Happens When You Miss the Best Days in the Market, But What Happens When You Miss The Worst
We have all seen the studies used to validate modern portfolio theory and buy and hold about how bad investors would do if they missed the best 10, 20, 30, etc days in the market. I always assumed that since the worst down days are usually worse than the best up days, that if you missed some of the up days and the down days you would still do better than buy and hold. I just came across a study Hepburn Capital Management that shows this ( thanks to James Henderson at Mast Investment Advisors who was nice enough to forward me the study):
S&P 500-25 Years Ending 12/31/2011
Buy and Hold Average Annual Return: 6.81%
Miss Best 10 Days: 3.67%
Miss Best 20 Days: 1.65%
Miss Best 40 Days: -1.62%
This clearly shows that missing the best days hurts returns, no rocket science here. Here’s what happens if you miss the worst days:
Miss Worst 10 Days: 10.89%
Miss Worst 20 Days: 13.55%
Miss Worst 40 Days: 17.74%
This clearly shows that missing the worst days is really good. However, just like the results from missing the best days, this is pretty much useless. No active investment strategy is going to be unlucky enough to miss the best days or lucky enough to miss the worst, only Nostradamus could do that.
Next is chart about what happens if you miss the best AND worst days:
Miss 10 Best AND 10 Worst: 7.78%
Miss 20 Best AND 20 Worst: 8.14%
Miss 40 Best AND 40 Worst: 8.52%
This shows two important points:
1.Missing the worst days is more important than not missing the best days (something we have always known)
2.The argument that investors should always buy and hold based on missing the best days is invalid. There is no way that a tactical strategy designed to avoid large losses and stay in harmony with market trends will not miss some of the worst up days without also missing some of the worst down days.