Model Objectives

 

Of the sixty-eight years since WWII, fifty-three of those have been positive for the stock market. This means the market goes up about three out of every four years. So why then doesn’t everyone put most, if not all, of their invest-able funds into equities?  The answer, of course, is risk of loss. That fourth year can be, at times, absolutely devastating.

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Here are some statistics worth considering. On a month-end closing basis, between 1945 and 2016:
•    there have been 33 three-month periods with declines in the S&P 500 of 20% or more.  28 of them (85%) have occurred since January 1, 2000.
•    of the 30 worst 36-month periods in the S&P 500 since WWII, 27 (90%) have occurred since Y2K.
•    and the ten worst 36-month periods since 1945 all occurred in the 2000s.

The Low-Risk Investment Model (Model) is designed to reduce this risk of loss.

This Model is a trading/investing, or what some might say, “timing” system.  It is designed to reduce risks associated with stock market investing yet capture a significant portion of its gains.

“Timing” has long been considered a fantasy in investing circles. But this Model is not so much a timing system as it is a “conditions” model which evaluates the current economic factors which drive the stock market. It is synonymous with say, a 48 hour weather forecast.  These are far more accurate than the 5-day but certainly not guaranteed.  Over time, this Model has shown itself to be a valid, time-proven method to deal with risk.

I’ve always thought it defeatist to reject any conceivable strategy which could reduce market risk if it had any kind of timing associated with it.  Though many managers consider any such model to be taboo, what should really be taboo is Low-Risk photo 20summarily dismissing any indicators which could have avoided such market debacles like:
•    the nearly 50% decline between December 1972 and September 1974;
•    the crash of October 1987 when the S&P 500 dropped 28% in a week;
•    the post- ‘dot-com’ bear market of 2000-02 in which the S&P500 declined over 42%;
•    or the most recent bear market of 2008 in which the market literally crashed 50% in just 11 months.

Many investors can live with such personal financial distress. I choose not to.

Probably the most common risk-reducing strategy is “asset allocation.” I have no problem with any strategy which reduces portfolio risk and asset allocation is effectively used in most portfolios —  including mine.  Diversifying one’s assets is an investing imperative.  As such, it is important to know that this Model is intended for those investment funds already allocated to stocks or investable cash.

Those who have attempted to “time” the market have generally done so with either extremely short-term models (e.g., ‘day-trading’) or those so long-term as to be unworkable as a serious investment tool.  This model is designed to be more considerably more useful.

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What the Model does

The Model fulfills two of the primary principles of financial management: a disciplined strategy and the management of risk.

The first goal of all prudent investing strategies should be to manage risk.  As mentioned above, the most common risk-management method is “asset allocation.”  Clearly stocks provide the maximum return potential but also carry considerable risk of loss. Non-equity investment vehicles in a portfolio like bonds or cash provide lower return opportunities but are nearly always recommended for inclusion because they can cushion the impact of a stock market decline.  As important as the maximization of return is, it must take a back seat to the minimization of risk.

The Model is designed to give priority to run from the bears rather than with the bulls. The Model does not try to predict the future other than the use of analysts’ current estimates of future earnings.  The goal of which is to get into stocks for a chunk of major up-moves and (mostly) out of the market when the outlook is gloomy.

The Model’s eleven objective indicators, weighted primarily by past performance,  clearly satisfy the disciplined principle and their long-term results support the minimization of risk principle.

Low-Risk photo 10One of the Model’s secondary objectives is to minimize tax consequences. Seven of the indicators call for allocation changes far more often than the other four so these have been classified as “short-term” and recommended mostly for tax-advantaged accounts like IRAs.  One of the goals of the other four indicators is to minimize tax consequences by trading seldom enough to possibly capture long-term capital gains tax rates. But keep in mind that this goal will be subordinated to stock allocation reductions.

As a precious metal investor back as far as the late 1970s, I developed a comfort level with the inclusion of gold and silver in my portfolio. I have recently (January 2010) included a “gold” component into the Model as well. Since the price of gold was permitted to float by Richard Nixon in 1971, its price has been negatively correlated with stocks most of the time.

Consider that since the beginning of 2000 (through Dec. 31, 2012), stocks produced a total return of less than 2% annually. But gold grew by 15.7% annually! These periods when precious metals destroy stocks can’t be ignored so I haven’t with the Model.

So when gold is hot, the Model will reduce its stock allocations by 60% and this money will be moved to a recommended basket of ETFs and mutual funds with strong correlations to the price of gold.

I’ll elaborate more on this when the Model shifts from the stock market to gold which it will at some point. The Model was last in gold in March 2012.

[Note: Gold as used in the Model is as an investment vehicle. Historically gold has been both an effective hedge against inflation and economic or political chaos. Those who have concerns about the potential for such calamities ought to allocate a fixed portion of their wealth to either physical gold or silver, not paper investment products like ETFs or mutual funds. ]

 

What the Model does not do

The Model does not guarantee success.  Over the years the eleven indicators, which comprise the entire Model, have changed considerably. (E.g., Early on, interest rates had a far more significant influence on market direction than they have in recent years.)

Of these eleven indicators, seven (weighted 60%) are short-term oriented.  These seven trade more often than I would prefer but they’ve proved effective over the years so I can’t abandon them.

Nor is this Model a perfect investing method. It has flaws and has lost money in some years. (E.g., a 14% loss in 2008.)

The Model will also never match the performance of a major bull market. The only way to do so would be 100% invested in the market for the entire bull run. Since 2000, the Model has only been fully invested in stocks 2% of the time.

The Model’s indicators are constructed using arbitrary and back-tested criteria which may or may not be as effective going forward.  Obviously this clearly does not ensure success, but it has a good chance to reduce the odds of failure as it mostly has done in the past.

Neither this website nor the Model will make specific stock recommendations. To put it another way, the Model focuses on whether the “tide” will raise or lower the boats in the harbor, not which particular boat to choose. Having said that, most will find that many ETFs are quite compatible with the way the Model functions.

 

Other concerns

All trading models rely on past market behavior. Such market behavior is driven by infinite variables influenced by general (and personal investor) economic and political conditions most of which are never duplicated.  As such, some  models or indicators which have been highly successful in the past can head south in a heartbeat and end up about as effective as a coin flip.  But many others, used routinely in a variety of disciplines, have achieved considerable predictive success.

Though stock market variables may be infinite, market movements are limited to three: up, down or sideways.

Of the three, up or down is no problem if one is long, short or (out of) the market respectively.  Sideways though can be a major problem for a timing model.  Such sideways moves are called “whipsaws” and are always quite challenging.  It forces subjectivity into what is intended to be an objective exercise. This is always dangerous.

This Model will never be immune from economic or political shocks like when the S&P 500 was cut in half within little more than a six month period in late 2008 into early 2009. We were about 50% in stocks and the model portfolio took a serious hit.  Indeed, the Model had its worst year ever in 2008 losing 14.3%.

A serious dependence of the Model is that its inputs rely on information provided by other organizations. So long as there is a consistent flow of such, it will be updated on a weekly basis.  I’ll continue to seek secondary sources a problem does not arise but as with most other aspects of the investing business, there are no guarantees.

Perhaps the greatest current weakness with the Model is its dependence on me and my health.  At this point in time I have no back-up but if the site becomes reasonably popular, I’ll try to fix this as well.