With Fed Stepping Back, Your Portfolio Needs You To Step Up And Lead
Investing And Retirement Planning Can Induce Stress
With the Federal Reserve continuing down the tapering path, and the S&P 500 nearly flat for the year, it is becoming obvious that 2014 will be more difficult for investors than 2013. A more difficult year means a more stressful year. Stress can be thought of as the gap between where we are and where we want to be.
Markets Are A Difficult Nut To Crack
Anyone who has worked on Wall Street or managed their own investments will have little trouble agreeing with the following statement:
The financial markets are a difficult place to succeed, even for those who have flourished in other areas of their life or career.
Therefore, there is no shame in having some missteps on your investment resume. Like anything in life, we cannot expect to see improvement unless we are willing to make some positive changes.
Stress Is A Call To Action
It does not matter whether you are a professional trader or someone who is investing for retirement; the odds are good you have some holes in your approach to the financial markets. Stress is nature's way of helping us identify those holes. While there is no system or investment approach that can eliminate stress, there are things you can do to improve your odds of investment success, while greatly reducing stress related to bullish and bearish scenarios for both stocks and bonds. If you are tossing and turning at night, the first step toward sounder sleep is to leverage the simple and powerful concept from David Schwartz's book The Magic Of Thinking Big:
"Action Cures Fear."
Action Speaks To Leadership
The sun is still shining on the current bull market in stocks and the bond market has not blown up as of this writing. This year's indecisive stock market is a gentle reminder that it is always prudent to have investment contingency plans. Leaders take action when action is needed. A recent article on the importance of leadership in organizations provides some valuable insight for all investors. From Forbes:
Anybody who has ever watched interviews with managers or coaches of professional sports teams will have heard plenty of discussion of the need for leaders throughout the team. The same thinking is also increasingly a preoccupation of business people. Indeed, the need for "leaders at all levels" is one of the 12 critical issues identified in the Global Human Capital Trends 2014 survey published earlier this month by Deloitte University Press. In a paper examining the findings, Adam Canwell, Vishalli Dongrie, Neil Neveras and Heather Stockton point out that leadership "remains the No. 1 talent issue facing organizations around the world", with 86% of respondents to the survey rating it "urgent" or "important".
If organizations believe leadership is the No.1 talent issue, then it is not surprising that busy people find it difficult to provide the leadership necessary to get investment contingency plans in place for their personal nest egg.
Your Investments Need Leadership
If your plan for investment success can be summed up with "I will figure it out as the investment landscape shifts over time", your probability of success will be quite low. Traders have much shorter time horizons than investors, but they have one thing in common; ad hoc and seat-of-the-pants traders are rarely successful. Professional traders who have a long history of producing above average results tend to spend much less time tossing and turning at night since:
- They have identified and understand what their edge is in the markets.
- They have risk management rules or systems in place to protect their hard-earned capital.
- They have backtested, but not curve-fitted, their approach to investing.
- They understand how markets price assets and their role within the bigger picture.
- They follow their systems and rules religiously. They do not rationalize away information from the markets.
- They have decided in advance how they will approach both favorable and unfavorable markets.
Successful Investors Have Spent Time In Quadrant Two
For those who have read Stephen Covey's The Seven Habits of Highly Effective People, you will remember the four quadrants that help identify activities that generate positive results.
How did the top traders on Twitter become consistently helpful sources of market information? They spent time in quadrant two honing their skills and perfecting their systems.
Do You Need To Set Aside Some Quadrant Two Time?
When testing your current approach to the markets, it is helpful to look at extreme outcomes. If you can handle the extremes, then you can handle almost anything in between. Therefore, if the questions below induce a high level of stress and uneasiness, it may be time for you to provide some leadership for your portfolio. Do you have specific and implementable plans in place for the three scenarios below?
- Case A: stocks and bonds fall simultaneously as they did in 1994.
- Case B: stocks rise an additional 91% over the next three years as they did during the final leg of the dot-com bubble (1997-2000).
- Case C: stocks drop over 50% as they did in the 2000-2002 and 2007-2009 bear markets.
Investment Leadership Is A Quadrant Two Activity
Individual investors have two "action cures fear" paths to take to improve their odds of investment success and worry less about the three market scenarios listed above:
- Path One: Build your own system to address the three extreme cases above.
- Path Two: Find an existing system or strategy that can handle all three cases.
The First Step Is Making A Decision To Take Action
Acknowledging the need for contingency plans and making a decision to do something about it will have a stress-reducing effect. A good next step is to set aside some quiet time when the markets are closed to outline a plan to move down one of the two paths above. If you want to build your own system, an article from last October may spark some ideas. If you decide to get some help from an advisor or money manager, make sure their approach to the markets passes the "that makes sense to me" test. Even the best systems in the world experience frustrating periods that require patience. A manager's system is useless if you cannot stay invested during bumpy periods. Compatibility of philosophy between you and your manager will make it much easier to stay within the confines of the disciplined approach.
2014 Investment Implications - Slowing Momentum Means Higher Risk
The present day market has some similarities to all three of our extreme periods:
1994: Janet Yellen hinted at higher interest rates
1997: The S&P 500 recently broke out of a 13-year base.
2007: Tepid economic data has lead to slowing bullish conviction.
While we are not fans of forecasting, the big picture in March 2014 is more in line with the increasing probability of a stock market correction, rather than a shift into a full-blown bear market. However, corrections can last several months and can do considerable damage to your portfolio and sleep cycle. The tweet below from Thursday morning sums up our current approach to risk management.
The stock market has moved sideways for three months, which is a sign of slowing bullish economic conviction and increasing bearish economic conviction (see orange box below). If the S&P 500 closes below 1,841 it will represent a lower low, which follows a recent lower high (both are concerning).
Vulnerable Does Not Always Morph Into Bearish
The stock market was in a similar vulnerable state in the first quarter of 2013 and regained its footing without a significant correction. That may or may not happen in 2014, but at a minimum the market's current profile calls for bearish contingency plans in the event the bears begin to gain some traction. As of Thursday morning, we have made no significant chess moves this week. We continue to maintain exposure to U.S. stocks (SPY) and technology stocks (QQQ). The incoming data and charts will guide us in either direction if we remain patient, disciplined, and open-minded.