A primary focus of the first post in this series of articles, Safe Ice-Part I, was the development of a personal approach to allocating investment funds. Gaining an understanding on what one’s own approach should be along with developing a framework and tools to understand the likely future returns and safety of principal for a given investment choice were given as the two elements of a personal method of investment. The initial post referenced The Battle for Investment Survival(G. Loeb) in developing a personal investment approach. It’s When you Sell that Counts(D. Cassidy) will be used in this article to provide confidence in evaluating market tops and bottoms, as well as develop a quantitative indicator of when conditions for buying and selling aggressively may be warranted.
One of the principal tenants of this book is that periods of extreme undervaluation and overvaluation can be identified clearly, if one is willing to be a bit contrarian during such times.
“Mechanistic models that base predictions of one cycle on the size and length of its predecessor are (or on theory based simply on prior averages) doomed to failure. Live, proactive human beings, by observing psychological conditions in the market, can successfully identify areas of temporary extreme valuation, high and low…This is the essence of contrarian investing. No pretense is made here that exact tops will be identified and sold nor precise bottoms bought.”
Five factors were highlighted as particularly helpful identifiers of extreme periods of asset valuation:
- Above-average longevity
- Acceleration of price velocity on high volume
- Extremely steep slope of price movement
- Virtual unanimity of opinion; downplaying of risks(at tops) or opportunity(at bottoms)
- A loud media drumbeat praising or bemoaning those above conditions
If an individual had the good fortune to have $10,000 of investable cash available in November of 1915 and speculated in the same stocks with the same proportions as represented by the Dow Jones Industrial Average(DJIA), and then sold in December of 1951, their cash(adjusted for inflation) would have grown to $10,820.501. If the investor chose to reinvest the initial $10,000 stake along with their $820.50 of paper profits into a basket of stocks mirroring the DJIA and held it until December, 1980, their holdings would have grown to $11,896.54(adjusted for inflation), providing total profits of $1,896.54.
A speculator with $10,000 of investable cash who made the exact same allocation decision2 as the aforementioned individual in November of 1982 would have had a portfolio value of $110,339.75 as of December, 2020.
That the buy-and-hold strategy for a broad index of stocks has returned 1,000+% over the past 39 years is a bit of an exceptional snapshot of time. This does not prove point #1 above, but does seem to indicate that it is at least possible that we are currently experiencing such an environment at present.
I believe that points #2 & #3 can be demonstrated by a simple chart of the Nasdaq Composite Index. Volume has risen over the past 2 years, and does not appear to be at an extreme peak, but the value of the Nasdaq has clearly accelerated since the Covid-related dip in February and March of 2020. Although it isn’t unreasonable to expect a bounce off of those lows, the Nasdaq being up ~90% off of those lows does seem to be an unlikely expectation.
Source: MSN Money
On points #4 & #5, one can take time to reflect on what one has been hearing from friends, family, and in news coverage and assess qualitatively whether or not the conversations have become more less involved with the economy and investments in recent months, or even the past couple of years. Perhaps a game of word association would help bring clarity to whether this is occurring in your sphere or not…Bitcoin, All-time highs, yields, interest rates…My personal belief is that the conditions of both points are very much in effect at present.
- Back-of-the-napkin calculations performed by using hand-picked data from the 100-year DJIA historical chart available on Macrotrends.net. Not a project that would be submitted for thesis approval at any MBA program.
- I understand that the DJIA does not seem to be as representative of the state of the economy and markets as it once did and that other indexes may depict these variable more accurately. This makes the DJIA performance even more remarkable during this time frame.
I am not a financial services professional. All information on this site should be regarded as informational or for entertainment only, and not as actual investment advice.
Disclaimer: I own put options on SOXX, which are expected to go up in value if a market correction occurs, and expect to sell or add to the position at any point in time.