As the calendar flipped over to 2015 earlier this week, Matt and I both wrote brief articles dealing with the inevitability that bear markets always follow bull markets. As we near the end of this bull market's sixth year, making this already one of the longest bull markets of the past century, it's natural to start thinking more about when it might end and the implications of that happening.
Hopefully long-time SMI readers already recognize this, but we don't advocate making big changes to your portfolio as we move through the bull/bear market cycle. The data seems to clearly indicate that most investors wind up making counterproductive moves when they try to figure out when to be bearish or bullish. And we don't play the market-timing game here at SMI, trying to guess when to move out of stocks and into cash and vice versa. Apart from the built-in asset class changes in our Dynamic Asset Allocation strategy, we generally encourage investors to stick with their long-term allocations through bear markets.
Yes, in the past we've offered guidance about how to make relatively modest changes when bear markets seem imminent (and we'll write about the Bear Alert Indicator eventually again when conditions warrant - we're a long way off from that point now). But even our Bear Alert is more a concession to human nature than an attempt to improve investing returns. In other words, we know some people are going to do something when a bear market arrives even if we tell them to just sit tight. It's not that we think acting on a Bear Alert is really a helpful thing as much as we'd rather have those readers take modest and well thought-out actions (under our instruction) rather than sell everything in a panic.
So here's where we stand today. We don't think a bear market is imminent. The reason for these semi-bearish sounding articles this week is that SMI often serves as a counter-weight for our readers against the dominant emotion of the moment. For the first few years of this bull market, the dominant emotion was fear — a steady diet of "don't trust this rally, an aftershock is coming, the next shoe is about to drop." Against that dominant emotion, our message was to encourage readers to continue following their plans and invest. We tried to balance the negativity with what we thought was a reasonable rationale for why this bull market was likely to surprise investors both in terms of its gains and its length.
Now that we're much further along the bull market progression, we aren't hearing as much persistent negativity. This is perfectly normal for a bull market — emotions always shift from fear to confidence as a bull market lengthens. But as that happens, our job also shifts, from having to drag investors out of their bomb shelters to reminding them that no bull market lasts forever. That's all we've been trying to accomplish this week. As the general market mood gets more enthusiastic, we're going to increasingly play the role of reminding you to keep an eye on your risk levels.
We've had some questions in response to this week's posts, with variations on the idea of "If we're moving toward a bear market, should I be changing my portfolio mix?" Some have specifically mentioned the 50% DAA, 40% Upgrading, 10% Sector Rotation portfolio we wrote a cover article about in May 2014, wondering if they need to change that.
As I've indicated, we don't generally approach the process that way. For most readers, they're best served by figuring out a portfolio mix they can stick with in good markets and bad, then just riding that out. The 50/40/10 portfolio was specifically designed to be that type of "all weather" portfolio, with certain pieces that should excel during the bull phase and others that should excel during the bear phase. If you're using that type of portfolio mix, we feel like you should be able to hold up pretty well whenever the next bear comes.
That said, there's nothing wrong with making small adjustments to your portfolio mix if you want to be more active. Just understand that you don't need to. In fact, if you don't naturally want to do anything along the lines of what follows, don't! Some will read this and think, "why would someone want to make it more complicated like that?" The reason I share ideas like this is we get a lot of questions from those readers who are more active, or are tinkerers, or whatever, and they enjoy trying to optimize their portfolios using these types of ideas.
So, for the tinkerers among you who might want to be more active, how might you approach it? One thing that I do in my own portfolio is to think more in terms of certain ranges for each strategy, rather than a certain fixed percentage. For example, in a perfect world, I would like to be more heavily invested in Upgrading and Sector Rotation early in bull markets when the strongest upside moves for stocks are expected to be ahead. Likewise, I would like to be more heavily invested in DAA when bear markets arrive, because it has much better downside protection built into it. The only problem, of course, is they don't ring a bell when the market is about to transition from bull to bear or vice versa!
That said, it's not unreasonable to think that a person could gradually shift their portfolio mix between these strategies. (As long as you understand you won't get it perfectly right.) So, as an example, perhaps instead of having 50% in DAA all the time, you might go with a range of 40%-60% in DAA, with the goal to have less DAA through the early bull market years and gradually add to that as the bull market goes along. That would come at the expense of any allocations to the more aggressive strategies, naturally.
I've used this to a small degree in my own portfolio, tending to swell and reduce my exposure to Sector Rotation in small steps. Now that we have DAA, I've started using that a bit more in this manner also. It's not that I'm jumping in or out of any of these strategies — the core of the portfolio includes all three, all the time. But the amount of each ebbs and flows — based more on the general duration of the market phase we're in than any particular prediction or expectation. This year I plan to back off my Sector Rotation and Upgrading holdings somewhat and add to my DAA holdings as the year goes along. I may be a year or more early, who knows? If I am, I'll keep adjusting a little more in that same direction next year.
But note two things about what I'm doing. First — I didn't start this "make it more conservative" progression too early! If you're going to be inclined to jump the gun, this type of approach probably isn't for you and you'll likely be better off with a middle of the road "set it and forget it" approach. Second — even at the most aggressive and conservative extremes of the ranges, you should never be tilted too far away from your "base" starting point. Hopefully that's common sense: you don't know what's coming, so you never want to be positioned in a way that's going to really damage you if you're wrong. We're talking about relatively small shifts here, maybe taking your 50% normal allocation to DAA and going 10%-15% to either side. Something in that range.
Again, there's no need to add any of this complexity if you prefer not to. Don't feel like you're missing out on anything. The strategies will work just fine without the extra effort and activity. The 50/40/10 article I referenced earlier didn't involve any of this extra activity, yet it performed great with a fabulous risk profile. Feel free to stick with the basic versions, or add a little extra as you see fit. As always, we explain the ideas and leave it to you whether or not you want to build them into your portfolio. That's the formula we've used to appeal to and balance the desires of such a large and diverse audience for all these years.