So You’re a Buy-and-Hold Investor? Really?

In another mostly uneventful week, the S&P500 slipped 1.6% on somewhat higher volume, which is of course, what we’ve come to expect whenever the stock market falls. Also not unexpected, volatility nudged higher during this down week; that said, it’s not too far away from the lower end of its long-term range.

Despite the modest retreat in prices last week, the technicals are still screaming “over-bought”, especially on the weekly charts where the price drop was barely visible. Prices on the longer term charts are still very much hugging the upper Bollinger bands. Measures of breadth deteriorated on the week—the McClellan oscillator registered a notable drop. And the percent of stocks above their 50 day moving averages also slipped quite a bit.

Unlike the prior week, there were quite a few economic reports released last week. Personal spending and personal income both missed expectations. Construction spending also missed badly—falling 1.1% instead of rising 0.3% as expected. Initial jobless claims disappointed by surging higher, well above expectations. Factory orders also missed by a wide margin, and so did consumer credit, which rose by far less than the consensus estimate. On the positive side, PMI manufacturing beat expectations, as did PMI services. Finally, the big number of the week, payrolls—on the surface—beat expectations. Jobs grew by 295 thousand instead of the 230 thousand expected. The caveat is that by far, most of the job growth came from part-time (and low-paying and non-benefited) jobs in areas such as hospitality and retail. Think bartenders and store clerks. Also, disappointing was the fact that average hourly earnings grew half as much as expected and the fact that the labor force participation rate fell—this means that while unemployment rate looks good, whereas behind the scenes, a smaller percentage of the population is actually working, which is not so good.

Finally a word about all the enthusiastic stock buyers and owners over the last several years, who’ve enjoyed tremendous success as the US stock markets have continued chugging higher despite the cautions and warnings from many of Wall Streets most experienced analysts.

The fact is that most retail stock market participants jump in well after stock markets have made huge moves higher, thereby missing a large portion of the move. Why did they have to “jump in”? Since most claim to be “buy and hold” investors, why weren’t they already in the markets from the beginning of the move?

It turns out that most retail investors also don’t really have the stomach for big losses, and end up getting out—and losing money—near the bottoms of big market down moves.

Here’s how veteran investment manager John Hussman puts it:

Investors often convince themselves to follow a buy-and-hold strategy only after lengthy market advances, and even raise their expectations about the level and safety of future returns at exactly the point when elevated valuations imply poor long-term market prospects …… They later abandon their buy-and-hold convictions after lengthy market declines. What I am urging is that investors vividly imagine realistic market losses ahead of time (the 2000-2002 and 2007-2009 declines each wiped out half of the stock market’s value, and the average run-of-the-mill cyclical loss exceeds 30%). One may believe that the timing of such losses is unpredictable, and that’s fine. The point is that such losses are the way that market cycles regularly conclude. Even Jack Bogle, for whom we have great respect, encourages investors to “prepare for at least two declines of 25-30 percent, maybe even 50 percent, in the coming decade.” That’s not a timing call. It’s simply historically-informed realism. Particularly in light of current valuations, investors should set their portfolio allocations to allow for such risk without later abandoning their discipline if it becomes painful.

So just remember that good times NEVER last forever in stock markets and that when the inevitable downturn finally arrives—be prepared to ride out the entire roller coaster move….which is what buy and hold investors MUST do to truly adhere to their professed approach to investors.

Historical evidence strongly suggests that most will not be able to do this. So the challenge will be to determine if you’re able to break this tendency—-to sell out near market lows, and thereby booking major losses, just before the markets begin their major rebounds.


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