I'm the Chief Investment Officer of Nerad + Deppe Wealth Managment, a fee-only Registered Investment Adviser based in sunny San Diego, CA. investing for success over the long term is more than just a pie chart and annual rebalancing.

I believe i can help you prudently manage your investment portfolio. 

S&P 500 - Piling Up The Points, But Defense Wins Championships.

While watching the Oklahoma vs. Georgia college football playoff semifinal, I couldn't help but think about the game's parallels to the full market cycle for the S&P 500.  Oklahoma started incredibly strong, piling up points early and often and completing a near flawless first half by scoring on 5 of 6 drives with 4 touchdowns and 1 field goal, analogous to the early stages of a new bull market.  However, Oklahoma's momentum would slow, and Georgia began to own the trenches as their defense completely took over in the second half.  Oklahoma's lead would experience a meaningful "correction", as what was once a 31-14 Oklahoma lead, suddenly became a 38-31 Georgia lead.  The Sooners would then mount one more rally, scoring 14 points in under 2 minutes to take a 45-38 lead, which reminded me of the final rally of a bull market.  It's the last gasp jolt to new all-time highs that leads most everyone to believe the bull market is alive and well, when really it's in hospice (think Sept & Oct '07).  Georgia would then control the action from there on out, and the narrative would go down as the old classic phrase -  "defense wins championships".  

The S&P 500's price action at the moment is the equivalent of Oklahoma's first half; it's piling up points left and right and seemingly unstoppable.  When including dividends, the index has increased 14 consecutive calendar months, 9 consecutive calendar quarters, and 9 consecutive years.  When excluding dividends, the index has increased 9 consecutive calendar months, joining Aug 1982-April 1983 as the only other 9-month price-only winning streak since 1970.  It's rather safe to assume that the large majority of long-term investors who've been putting their offense on the field (i.e., passively maintaining a meaningful equity allocation across their investable portfolio) have built a tremendous lead, with lead being defined as your unrealized gains over the last five-plus years.  But as Oklahoma taught us all on Monday, no lead is safe if you don't figure out how to play defense.  Playing defense in the world of portfolio management is defined as having a prudent, intelligent, and defensible risk management plan.  

Now, the point of this post isn't to suggest that long-term investors need to put their defense on the field immediately, nor is it to predict that their offense is ready to lose possession.  There's a plethora of evidence to suggest that more points will be scored over the course of 2018.  For example, I find recent strength in the SPDR Consumer Discretionary (XLY) and SPDR Consumer Staples (XLP) sector as an encouraging statement from market participants re: the consumers bill of health (healthy) and risk of recession over the next 6 months (low).  XLY and XLP both gained more than 5% in November alone.  Since inception for XLY & XLP, there are 7 calendar months where XLY and XLP both gained 5% or more with the SPDR's S&P500 Index Fund (SPY) also closing the month above its 12-month simple moving average.  SPY's forward 6- and 12-month total returns from month-end signal date have never been lower, with the average forward 6- and 12-month returns being 9.79% (although I'd be remiss in not pointing out that the last two most recent samples saw relatively weak forward returns over 6 and 12 months).


Additionally, we have the prospects of yet another "Whaley Bullish TOY" buy signal (click here if you have no idea what i'm referring to).  A "Whaley Bullish TOY" buy signal is triggered when the S&P 500 gains 3% or more from 11/19 of the prior calendar year through 1/19 of the current calendar year.  With 11/19 of 2017 falling on a weekend, Wayne uses the S&P 500's close on the Friday prior to 11/19 .  With the S&P 500 closing at 2,578.85 on 11/17/2017, a "Whaley Bullish TOY" will trigger with any close above 2,656.21 on 1/19/2018.  This is obviously yet to be determined, but it's certainly something I'll be watching closely over the weeks ahead. 

Back to the point of this post, which is to remind long-term investors that there is no better time to prepare your defense, or risk management plan, than when your offense is on the field.  If your defense isn't ready when they need to take the field, you're liable to give up points and lose some or all of your lead.  If your defense is ready before they need to take the field, you might be able to able to hang on to your lead - which in this analogy is the equivalent of your unrealized gains.  

There are many ways for investors to build a prudent, intelligent, and defensible risk management plan.  However, almost all risk management plans begin with two simple ingredients often called "triggers" and "adjustments", and end with what I call a "stop-and-reverse contingency".  A "trigger" can be viewed as an event that occurs that then causes, or "triggers", portfolio rebalancing to take place.  Now, I don't believe that "triggers" should be based exclusively on individual investor attributes, or a change in the calendar year, but instead should pertain to asset classes.  For example, I'd argue a "trigger" such as your birthday, an emotional change to your risk tolerance, or your annual meeting with your financial advisor, are not sufficient reasons to rebalance your portfolio.  Instead, long-term investors should consider defining the primary trend across the broad asset class investable universe in a quantitative, objective, and mechanical fashion, and then use changes in those primary trends as a reason to "trigger" portfolio rebalancing to overweight or underweight specific asset classes.  This will allow for favorable portfolio drift over the bullish portion of the market cycle, rather than selling winners and buying relative losers each and every year for no other reason than another birthday.  Now, since trends can last years, I believe the most optimal "triggers" are those that balance the need for time in the market to experience meaningful capital appreciation during the bullish portion of the market cycle, while also timing the market in order to preserve capital during the bearish portion of the market cycle.  Think monthly charts, not minute charts.  Since the S&P 500's primary trend as of today is up, or "bullish", long-term investors should identify a "trigger" that they can adhere to at any point into the future to realize their capital gains.  Don't let Wall Street fool you, it's not "you don't lose any money until you sell", it's "you don't make any money until you sell".  

So if "triggers" first alert us to rebalance our portfolio, then "adjustments" pertain to what asset allocation you should rebalance your portfolio to after a "trigger" occurs.  First, the argument in support of attempting to make meaningful "adjustments" to your portfolio's asset allocation at opportunistic times perhaps lies in nothing more than the philosophical differences surrounding the alternative, which is to knowingly plan to not make meaningful "adjustments" into the future, or what's often referred to as "strategic asset allocation".  The idea that there's one broad static asset allocation as of today that an investor should adhere to into the future, with only minor "adjustments" planned over time that are mostly driven by an investor's age or shrinking time horizon is something that just doesn't make sense to me.  While I do recognize the realized long-term successes and merits of "strategic asset allocation" (i.e., your local financial advisor's diversified pie chart, annual rebalancing, minimal adjustments, and nothing more), I believe this is mostly a derivative of a coordinated bull markets across both stocks and bonds the last 40 years.  Excluding dividends, the S&P 500's increased 31 of the last 40 full calendar years, and with dividends I believe we can add in another positive year or two.  The Vanguard Total Bond Market Index Fund (ticker symbol VMBFX) has increased 25 of the last 28 full calendar years.  It's no wonder investors holding a passive mix of stocks and bonds and practicing annual rebalancing based has treated them so kindly.  That said, this is the view out of the rear view mirror, where there's flawless visibility.  The view out of the windshield is perpetually foggy, with little visibility.  I don't think the next 40 years look anything like the last 40 years given present valuations across both stocks and bonds - and this is partly why I'm skeptical of "strategic asset allocation" investment methodologies being able to duplicate their historical successes. 

Instead, I believe a long-term investor is best suited with an investment strategy and asset allocation methodology that's dynamic, flexible, and tactical to allow for meaningful "adjustments" to their asset allocation to be made in order to align their portfolio with the prevailing trends across asset classes after a "trigger" occurs.  Defining "adjustments" is an art, not a science, and they certainly don't have to be binary, all in or all out of any particular asset class.  They can be tailored to fit with a long-term investor's risk tolerance, time frame, and perhaps most importantly, the minimum rate of return necessary to fund stated financial objectives based on reasonable financial forecasting.  However, "adjustments" must be planned in advance, a long-term investor should know the "adjustments" they'll make when a "trigger" occurs long before the "trigger" actually occurs.  Since the primary trend for the S&P 500 in the present is up or bullish, the primary trend into the future can only be down or bearish, although nobody can circle the date as to when this trend change "triggers".  But if you can identify the change in the S&P 500's primary trend from up to down shortly after it has occurred, you can then make meaningful "adjustments" to your asset allocation to reduce equities and increase cash and equivalents and/or fixed income investments in an effort to "batten down the hatches" during a potential "bear market".  In the event the S&P 500 is actually throwing a 12 to 6 curve ball - and everything you've read on Zerohedge and in Hussman's Weekly Market Comment is coming to fruition - then these "adjustments" will likely be looked back upon as the best decision a long-term investor could have made.  

This brings us to the final element of building a sound defense, which is the inclusion of a "stop-and-reverse contingency".  Anyone attempting to make meaningful "adjustments" to their portfolio's asset allocation at opportunistic times has to understand there are going to be "triggers" and "adjustments" that hindsight will define as completely and totally unnecessary.  All sorts of "triggers" could have been firing to de-risk your portfolio in the summer of 2010 and 2011, or August of 2015, or January of 2016.  Additionally, all sorts of "triggers" could have been firing to add risk into your portfolio in the fourth quarter of 2001, or the second quarter of 2008 (bear market rallies are notorious in leading investors to believe the bottom is in).  Meaningful "adjustments" as a result of these "triggers" can create both opportunity loss and realized loss, the degree of which is maximized if the investor didn't have a "stop-and-reverse contingency".  Put simply, anyone de-risking their portfolio in January of February of 2016 without a "stop-and-reverse contingency" has probably missed a metric ton of the advance since March of 2016.  This is why Brian Kelly's "go to cash" call on Fast Money in early 2016 drove me crazy, because it didn't include a "stop-and-reverse contingency" in the event he was wrong - and boy was he wrong.  Going forward, an above average correction may "trigger" long-term investors to make meaningful "adjustments" to their asset allocation.  If this correction morphs into a full blown bear market, those "adjustments" will save long-term investors portfolio values, helping them capture and retain the majority of the lead they've built over the years.  If it's only a correction, or a temporary decline that only interrupts our primary uptrend, a "stop-and-reverse contingency" will then limit the damage caused based on these unnecessary "adjustments" and get the ship moving back in the right direction - a la all of the buy "triggers" that went off in March of 2016.  

Remember, in the world of investing, unlike Oklahoma vs. Georgia, the game never ends...the score simply changes.  Investors have built a massive lead since 2011's bottom.  If you want to keep it, I implore you all to make sure you have a prudent, intelligent, and defensible risk management plan.  Write down your "triggers", "adjustments" and "stop-and-reverse contingency" for 2018 - and stick to the plan with maniacal discipline.  



S&P 500 - Back To The Start

SPXTR: 13-0 & More Bullish Clues Left in November