EC Correction Yes; Bear Probably Not Soon, But Possible — Key Indicators Discussed

The S&P 500 is the most important US stock index — most followed, most used as a benchmark, most used to measure and compensate fund managers, among the longest histories, and covering most of the market-cap of the US. That index is in a downtrend, and a more defensive positions is appropriate.

Moving averages are the simplest way to judge whether a trend is UP or DOWN. A trend, whether UP or DOWN remains in force until proven otherwise. No proof of a reversal back to UP is evident at this time.

Click on picture to enlarge

However over long periods, downtrends such as this become less of a problem as the length of the period increases (thanks to Frank Case of AlacrityConsultingAssociates for pointing us to this chart from Charles Schwab, which clearly makes the point).

Just how much more defensive you should be varies:

based on your time horizon before needing to draw on the portfolio for living expenses

based on your surplus or deficiency of assets for those near or in retirement

based on your level of conservatism or aggressiveness in your long-term allocation

based on the spread of your assets across tax-deferred and regular taxable accounts

based on your emotional capacity to withstand short-term fluctuations in your portfolio value

based on how reasonable your believe our market conditions analysis to be

and other factors

There are many forms of being more defensive, only one of which is exiting the stock market – for example:

selling some stock and holding tactical cash

substituting more aggressive stocks with more conservative stocks

increasing bond allocation while decreasing stocks allocation

purchasing long/short or market neutral funds

purchasing inverse funds

shorting index funds against individual stock portfolios

purchasing PUT options

purchasing certain minimally correlated alternative assets

Let me be very clear, the aggregate historical evidence is that attempting to enter and exit the market (except for major Bears, like 2000 and 2008, results in underperformance. You get out after a decline as begun, and get back in after a recovery has taken place (or worse yet, you are whipsawed and get in an out a few time during a cycle) with each round trip being less profitable than having stayed invested. Getting in and out is a two decision process, why and when to exit, and why and when to re-enter. For most people that means underperformance.

However, for those for whom preservation and avoidance of major drawdowns during periods of withdrawal is paramount, underperformance is an acceptable “opportunity cost” in exchange for “risk of ruin” (outliving assets). The risk of outliving assets is increased when a schedule of fixed or rising withdrawals is made from a highly volatile portfolio (thus the rationale for holding bonds as well as stock over the long haul); and is particularly dangerous if the early years of retirement are characterized by declining markets.

This chart for JP Morgan Asset Management shows the impact of being out of the market for certain numbers of top performing days from 1980 through 2014 (note that some of the top performing days are during early days of recoveries).