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The Tweet on the left below from Charlie Bilello makes a strong case for a passive, buy-and-hold investment strategy. Supporting his graphical evidence is a quote from investment legend Charlie Munger, alluding that investors should buy and hold and let compounding work its magic. Consequently, investors who panicked at the market low in 2020, sold everything, and did not buy back in would have surrendered significant gains. Compounding and the fortitude to stick with a passive strategy proved to be a winning combination over the last few years. Albert Einstein once said, “Compound interest is the world’s eighth wonder.” It’s daunting to challenge Munger and Einstein, but here we go.
Bilello’s graph assumes the extreme worst-case scenario: an investor sells everything at the low and doesn’t reenter the market. Let’s take the opposite case with a perfect active strategy. What if an investor sold the market peak in January 2020 and repurchased it at the bottom in March? The green line on the graph to the right adds this scenario to Bilello’s other two scenarios.
The point of this exercise is not to claim that calling market tops or bottoms is achievable but that active management, when done well, allows investors to outperform a passive strategy. Moreover, the benefits of compounding are greatly accentuated when active investing outperforms a passive approach. Furthermore, even if an active investor doesn’t perfectly time significant peaks and troughs, active management can still help you achieve better results than the market. However, we caution that poor active management decisions can result in underperformance versus the market.
What To Watch
Earnings
Economy
Market Trading Update
st week, we discussed the triggering of the weekly seasonal MACD buy signal. To wit:
“The WEEKLY S&P 500 chart, with three different signals, confirms the start of the seasonal period. With Friday’s close in the green, keeping the week broadly positive, all three seasonal buy signals have been triggered. However, just because the seasonally strong period of the year has technically started, it doesn’t mean that the markets won’t have corrections along the way. Notably, we have already had 6-straight weeks of gains, which is a long stretch without a pullback. Secondly, while the market is on a weekly “buy signal,” the market is both deviated and overbought short-term. When the market breadth is very elevated, combined with overbought and deviated markets from the 50 and 200-DMA, corrections and consolidations tend to be more prevalent.”
Unsurprisingly, the market stumbled a bit this past week, breaking the “rising wedge” pattern to the downside. While the correction has been mild, with the election looming, some further consolidation or reversal as portfolio managers “derisk” for election risk should be expected. However, the market continues to find buyers at the 20-DMA as portfolio managers are unwilling to be “out of the market” currently.
Notably, the market rallied to the underside of the rising trend line but failed at that resistance level. While the moving averages will provide some short-term support, we must remember that the negative divergence in relative strength and momentum remains.
As noted, there is currently little risk of a bigger near-term correction. However, some things could cause one, like a highly contested election. In the current political environment, such is not a low-probability event. As such, while we remain allocated to the markets, we are closely monitoring the amount of risk we take.
The Week Ahead
This week, earnings, inflation, employment, and election polling will make the headlines.
The BLS JOLTs and Employment Report will be released on Tuesday and Friday. ADP will shine additional light on the labor market on Wednesday. Economists expect to see a gain of 170k jobs, down from 254k last month. A downward revision to the previous month’s figure would not be surprising. Headline and Core PCE, the Fed’s preferred inflation gauge, are expected to increase by 0.1%. That data will be released on Thursday.
The markets have been pricing in a Trump victory with an increasing chance the Republicans take both houses of Congress. The daily onslaught of polls will either affirm the market or cause some consternation among investors.
As we share below, courtesy of TradingView, many earnings reports from some of the largest companies are due this week.
Low Forward Returns Are A High Probability Event
As stated at the outset, valuations are a terrible market timing metric. However, they tell us much about asset bubbles, investor psychology, and future returns.
No matter how many valuation measures we use, the message remains the same: From current valuation levels, investors’ expected rate of return over the next decade will likely be lower.
There is a large community of individuals who suggest differently and make a case for why this “bull market” can continue for years longer. Unfortunately, no valuation measure supports that claim.
But let me be clear: I am not suggesting the next “financial crisis” is upon us either. I am suggesting that based on various measures, forward returns will be relatively low compared to what we witnessed over the last eight years. Such is particularly the case as the Fed and central banks globally begin to extract themselves from the cycle of interventions.
Tweet of the Day
“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.”