Use of Secular Trend Concept for Asset Allocation in 401K, Update

By: Michael A. Alexander | Tue, Apr 16, 2002
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In a previous article, I described how I have been employing the concept for asset allocation in my 401K. I described what allocations I had made in my own 401K since September 3, 1999 when I moved completely out of equity in anticipation of the beginning of the secular bear market, which I believed had already begun the previous July. My strategy is simple, I hold only two assets, "equity" and "cash". I increase my cash allocation as the stock market moves "down" and increase it as the market moves up, with a deadband in the middle in which I do nothing. The equity component is the mutual fund American Century Ultra (TWCUX) which functions sort of as a cross between an S&P500 and NASDAQ index fund. The "cash" component is an asset-backed security fund that has been paying about a 6% return over the last 4 years or so and is still yielding (as of the last three months) about 5.7%. Like a money market, its share price is always a constant $1. The 401K at my company has no bond fund, so no bond allocation is possible.

Figure 1 shows a graph of American Century Ultra with arrows marking my 9/03/99 sale and subsequent repurchases of TWCUX. The region defined by the March 27, 2000 top and the April 4 2001 bottom in TWCUX corresponds to Table 1 in my secular trend application article. This table shows that historically, randomly selected investments made at the levels of rPR corresponding to the levels in this region showed positive one year trends in return about half the time. Thus, the idea is to buy in the lower half of this region and sell in the upper half of this region as I have marked in the chart. The problem with this neat idea is this "region" defined by the March 2000 and April 2001 extremes was not defined until after April 4 2001 and may not yet be defined if the market were to fall below the April 4 low in the next few months. Yet here I was buying before April 4. How were these buying decisions made? In my first article on this topic I described how I arrived at these buying decisions.

Figure 1. American Century Ultra (TWCUX) and buying (red arrow) and selling (black arrow) points.
American Century Ultra

The result of the analysis I presented was a series of levels (the blue lines labeled BUY in Figure 1) at which I would move 10% of my 401K from the income fund to TWCUX and series of levels (the black lines marked SELL in Figure 1) at which I would move 10% of my 401K from TWCUX to income fund. As of the time of that article (May 29, 2001), I had moved 10% from income to TWCUX five times on the dates marked in the figure and was 50% in TWCUX and 50% in income. I wrote:

If the S&P500 falls below 1100 in the coming months I will continue to increase my stock allocation in accordance with the blue lines. If TWCUX rises above 35, I will sell in accordance with the black lines. Once the situation is resolved I plan a follow-up article describing what I did and what comes next. Well the market did move below 1100 in the coming months and I bought again, on Sept 19. TWCUX was low enough to buy yet again on Sept 21, but as it is a fund, I wasn't sure of what its price was going to be that day. Besides, I figured (after I missed the buy and saw that it was "low enough") that I could buy the next day or next week on the retest (as it was almost certainly going lower). Well, that was as low as she went this time. It is completely possible that in the coming months we will go still lower than the Sept 21 lows and my allocation in TWCUX will increase, but for now it's at 60%. On the other hand, TWCUX could go up from here. If it does, another "sell" line is needed, which has been added to sell bars in Figure 1 as the green bar. Also shown in Figure 1 is a green line which shows how my 401K has fared since Sept 3, 1999. The answer is apparently not well. After being trounced by TWCUX right up to Oct 12, 2000, I have now started to be trounced by the income fund. Although I am now well ahead of where I would be had I not bailed out of TWCUX, I am way behind where I would be if I had just stayed put in the income fund. It seems I am destined to always underperform. This is a key property of an automatic investment method, like the one I am using here. It always underperforms in the short run. But it protects against future surprises. Although TWCUX had left me in the dust by spring 2000, I was not vulnerable to the decline in TWCUX that occurred after this date. As a result, my 401K is still above the level it was at on September 3, 1999, whereas a fully-invested position in TWCUX would be about 15% down from that time. Although I now lag the income performance I stand to gain should the market move up from here, which, after all, its going to do sometime. And if this does happen, I stand to rise above the 100% income performance shown in Figure 1 as the dashed line. Now one might ask, but if I had stayed completely invested in the income fund until now, I could move 60% to TWCUX today at a lower price than at which I actually obtained it. The net result would be the same as now, except I would be ahead some 6-7%. Of course the question would be, why would one do this? There is no more reason today to believe that the market is going to go up from here than there was last April, or in February 2001. There is never clear evidence when such a movement is going to happen. If there were we would all be rich. Now those who can detect such movements should use their skills to trade the markets. After all, a good trader can make money in all kinds of markets, bear or bull. But for an amateur like myself, I must resort to some kind of mechanical method like what I am trying here. I do not recommend that anyone do what I am doing, as I have no assurance that it will work. But articles like this represent the only sort of "real life" test that I can make of my secular trend ideas. It is sort of an "experiment" in my effort to develop a theory of practical stock market investing for "duffers" like myself.


 

Michael A. Alexander

Author: Michael A. Alexander

Michael A. Alexander
Stock Cycles

Mike Alexander is the author of four books: (2000) Stock Cycles: Why stocks wont beat money market over the next 20 years; (2002) The Kondratiev Cycle: A generational interpretation; (2003) Retiring Rich: The ultimate IRA and 401(k) investing guide (now available in paperback under the title Investing in a Secular Bear Market) and (2004) Cycles in American Politics: How political, economic and cultural trends have shaped the nation.

Michael is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

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