Market Overview

Bipolar bear

If this is a bear market, how come U.S. stocks rose almost 13% last month, and have kept trending up since?

While we – along with the rest of the financial community – are comfortable talking about the direction securities are going in “bull” and “bear” terms, they are only labels. They encapsulate concepts that are familiar and time-tested. But times change, and there are few features that are familiar about the economic reality we find ourselves in right now.

Maybe instead of thinking of Holsteins and Kodiaks, it’s more instructive to consider the space between, that is to say, volatility.

Crossing a line

It’s been a long time since we discussed an ongoing feature of this newsletter, the bull/bear oscillator. This is a mathematical model, known in academia as a moving average convergence/divergence indicator, which compares rolling averages of different periods for the S&P 500 index. The oscillator has been used in the technical analysis of stock values since the 1970s, and ours compares rolling averages of 25, 50 and 100 days.

It is a lagging indicator so, unlike typical technical analysis tools, it’s more for historical measurement than for prediction. Last month, the 25-day line took a sharp turn and crossed the 50-day line, illustrating that stocks were being sold off and suggesting a trend that this could continue.

That data point is intended to inform a strategy consistent with preserving capital while stock prices are falling. Such a strategy could involve rotating into countercyclical or noncyclical industries – pharmaceuticals or public utilities, for example. For some, it might also involve taking short positions or moving a portion of the portfolio out of stocks and into fixed-income securities, real estate, futures, collectibles or even cryptocurrencies.

This oscillator measures changes in investor perception of value rather than the actual movement of the S&P 500. While a bear market is generally defined as a drop of 20% from a peak, that definition is of little value when stocks swing sharply one direction one month and the opposite direction the next month. What the oscillator suggests is that, long-term, sentiment is still bearish. For months or years to come, indications are that stock prices will tend to settle lower despite what we’ve been seeing in recent days and weeks.

When averages are below-average

There’s a company in Boston called DALBAR that specializes in researching investor sentiment and behavior, and what it has to say about the typical retail investor is not reassuring.

A recent DALBAR study found that, over 30 years, the average investor underperformed the S&P 500. The index returned an annualized 10.35%, while the average investor return was just 3.66%. That’s a difference of 6.69% per year, every year.

The lesson to be learned is that volatile markets – and there were plenty between 1986 and 2015 – cause people to behave irrationally and make mistakes and then compounding them as they try to compensate and play “catch up”.

So, in times like these, when the markets can swing wildly from day to day, it’s wise to have a more nuanced view of market dynamics than just a “plus-20% is a bull market and minus-20% is a bear market” outlook.

Flying on instruments

Ultimately, though, we are each responsible for our own retirement planning, and an experienced financial professional would be scrupulous about understanding your individual goals and your risk tolerance. Regardless of how actively or passively you intend to monitor your retirement account, to what degree you want the process automated, or how much expert care you want your money manager to apply, it’s important that you have ultimate control.

Chris Lott, CFP®, CPA is a Managing Partner at Smith Anglin Financial, and is a member of the firm’s Investment Committee. He regularly meets with prospective clients, counsels existing clients, leads investment portfolio analysis and develops materials for communicating with the firm’s clientele and target markets.