When I see the deep blue sky as far as the eye can see and no clouds on the horizon, that's when I rush to sell everything. John Templeton (1912-2008) was always a practicing contrarian and with the sentence we have quoted he summed up the most counter-instinctive attitude that exists for those who invest. And in fact, however difficult, it is easier, if you are very liquid, to buy at bargain prices when there is a storm than to sell at high prices when everything seems to be going perfectly, everyone boasts dream performances and the neighbor tells in elevator who is earning more every week on the stock exchange than he earns in a year working and who is therefore thinking of quitting to go into trading.
And since ups last many more years than downs (which, however, are often deadly) contrarians who buy low too soon have less to wait to be right than contrarians who, by selling high in advance, risk spending years eating their guts, becoming ill-tempered and, if they are professional managers, seeing customers leave one after another because they do better elsewhere.
Templeton was never rancorous or ill-tempered, on the contrary he was always confident and optimistic about the world, supported by a great faith (he was an active Presbyterian, but his open-mindedness and great curiosity made him more similar to a Unitarian universalist) and, let's face it, also from the fact that he often had near-perfect timing in his investment decisions, such as when he bought everything he could in the XNUMXs.
Aware of this asymmetry between bottom and top, Peter Oppenheimer of Goldman Sachs went to study the cycles of the last century and came to the conclusion that selling three months after the market peak is no different than selling three months before of the peak. In the last three months of upswing, in fact, the market rises by an average of 7 percent and this is the same percentage that it loses in the three months after the top. The important thing, therefore, is not to have perfect timing on the top, but to sell before losing that additional 20-25 percent that the bear market takes away on average once it becomes structural.
Given these data, it can be concluded that, once inside the market, it's better to wait for the peak and sell a little below sometime later rather than sell too soon just because you start to feel overvalued. Let's think, for example, of those (including big names in the hedge world) who radically reduced the SP 2016 to 500 in 2000 because it was already expensive then, except to contemplate it today at 2500. Let's also assume that the top is today and that in three months the market fell by 7
percent. We would then sell at 2325, which would still be much better than the 2000 many sold at before the US election in November.
Easy, isn't it? However, there are two problems and they are not small.
The first problem is that not all declines start from a rounded peak. Some, like the one from 1987, take the form of a crash, i.e. fall vertically. This typically occurs after a period of low volatility during which short positions in Vix build up while stop-loss-based investment techniques become popular. The stop loss takes different forms and names from one cycle to another (portfolio insurance in 1987, Value at Risk in 2008, Risk Parity today) but always remains
the common element of automatic selling, now managed by machines, when the loss reaches a certain predetermined level. At that point, the downturn calls for another downturn in a spiral that can be devastating because it collapses in a time that is sometimes extraordinarily short.
In other words, while the bull market, even in the most exuberant phases, always maintains a certain order and leaves time to make one's choices before the rien ne va plus, the bear market, like an earthquake, can, at certain times, literally leave no time to escape. You wake up in the morning and see minus seven, time to pick up the phone and place the order and it's already minus eight, place the order to minus nine but the market is already minus ten and the order is not filled. You then best sell at minus eleven, forcing others who had their stops at that level to also sell at minus twelve, and so on. All operational risks which, in rising phases, are much more attenuated.
The second problem is that we only know the peak of a market cycle in retrospect. A 7 percent drop from the highs may be the last warning to exit and avoid the next big bear market but it can also be a simple correction, like the one in January-February 2016 or like the one the Dax suffered this year after (after!) the election of Macron.
So you have to use your head, and not necessarily sell. But the head can be wrong and so Oppenheimer proposes a model of signals (unemployment, inflation, yield curve, ISM, evaluation) to help us in the decision. A well-built model, his, with the only defect of indicating us, at this moment, a red alert. An alarm that its proposer himself decides, given the still expansive monetary conditions, to turn off and not follow up with another shareable consideration, the one for which we will probably avoid a bloody bear market, even if in exchange we will have to accept very low returns for many years .
All correct, with the added possibility that the markets, as they are already timidly beginning to do, will once again take into consideration the hypothesis that a tax reform in America will actually take place in the end. Trump's openness to Democrats (so far reciprocated) puts enormous pressure on Republicans to hurry up and, at the same time, involves moderate Democratic senators from the West who will have to present themselves to voters in a year. If the tax reform, albeit watered down, is accompanied by a non-restrictive Fed in 2018, a new upward cycle on the American stock market cannot be ruled out and it would be a shame to miss it.
To enjoy it, however, it will not be necessary to be 100 percent invested. Sooner or later, however, the top will arrive and gradually lighten up sooner, without completely giving up the final part of the rise, it will only be a test of wisdom.
