A Better Alternative To A Buy And Hold Strategy

A Better Alternative To A Buy And Hold Strategy

buy and hold does not workAnyone who has consistently read this blog, knows that I am not a fan of buy and hold investing, or as I like to call it – the buy and pray strategy. (The above chart is a great example). The problem (ie the myth of buy and hold) started back in the 1990’s. The 1980’s and 90’s were a great time to be an investor in U.S. stocks. Practically any strategy could be used and an investor would make money.  Mutual fund companies wanted to make investing seem easy and that everyone should do it. The mutual fund marketing machine was running full speed ahead.

The markets swelled to a point of extreme overvaluation in the late 1990’s, and the media was quick to suggest that we were on the verge of a “New Economy”. Many even went on to suggest the stock market would keep going up regardless of how overvalued stocks were. Then came 2000 – a new year, a new century and a new market. This new market had been sleeping for the past 20 years and had finally woken up — the Secular Bear Market.

Over the last 100 years, there have been three Secular Bull Markets lasting anywhere from 8 to 18 years, with the last being 1982 to 2000. There has also been three Secular Bear Markets lasting anywhere from 17 to 25 years. Numerous strategists and portfolio managers, including myself, believe 2000 was the start of the fourth Secular Bear Market.   The last Secular Bear Market was from 1966 to 1982, during which we saw five Bear Markets (over -20% corrections) ranging from a -24% to a -45% in durations lasting from 9 to 23 months over a 17-year period of time. However we also saw four Bull Markets (over +20% rebounds) ranging from a +32% to a +75% in durations lasting from 12 to 32 months and one Flat Market with a measly return of only +2% over a 26-month period of time. (One of only seven times the market has had +/- single-digit returns two years in a row in the last 100 years. Another time was just recently, 2004-2005.) So what was the end result of this 17 year Bear Market? The market ended where it started! If you invested in the S&P 500 in 1966, it was 16 years before you saw a gain, and 26 years before you had inflation-adjusted gains. If your investment time horizon is less than 30 years, does this sound like a good environment for a buy-and-hold approach?

1970 bear market -john rothe

To help answer that, let’s look at some of the characteristics of Secular Bear Markets. With the exception of the Flat Market that we previously mentioned, the last Secular Bear Market did have a lot of movement. However, instead of that movement being upward as we saw in the cherished 80’s and 90’s, it appears to alternate between one or two years of Bull Markets followed by a nearly equal one or two years of Bear Markets, repeating itself over and over again with what seems to be an invisible “lid” over the up-market peaks. Just as an up-market approached the level of a previous peak, down it went again.

Buy and hold investors who are hoping the current market returns to previous highs in the near future need to take a good look at past market cycles and realize that the buy and hold approach does not work well at all.

What about Warren Buffett?

Buy and hold fans love to point out that Warren Buffett’s strategy is to buy good companies and hold them forever. What they ignore is the fact that Mr Buffett gets a great deal on his purchases – a deal so good that neither you or I can get it.

US News recently wrote a great article on Buffett’s deals:

“Back in 2008, during the height of the financial crisis, Warren Buffett made a highly publicized investment in the Wall Street firm Goldman Sachs. Buffett was buying when everyone else was panicking, and as a result many experts thought he was getting into a top company at a discount price.

You, too, could have invested in Goldman Sachs in 2008. But here’s the difference between you and Buffett. If you had an extra $12,000, you could have purchased 100 shares of Goldman common stock at $120 a share. Considering that Goldman had been worth over $200 a share the year before, you might have thought you were getting a pretty good discount. You also would be receiving the Goldman dividend of $1.40 a share, a rate of just over 1 percent.

But Buffett had more than $12,000 to invest. He had $5 billion. So he negotiated a much better deal. He bought preferred stock that came with a special dividend. Instead of 1 percent, he negotiated a 10 percent dividend. So now every year he receives a check for $500 million. Then, only after he gets paid, do common stockholders get their paltry 1 percent.

So now, three years later, how have we done? Goldman is selling at roughly $110 a share, slightly below its 2008 price. If you had invested with Buffett, you would have lost about $1,000. Buffett’s lost some capital too, but he’s collected $500 million a year in his special dividend.

Buffett made a similar deal with General Electric. In 2008 he bought $3 billion in preferred shares with a 10 percent dividend. But you wouldn’t have done well to follow him. The stock was selling at around $21 a share in the fall of 2008. Now it’s running between $15 and $16, a loss of over 20 percent. But remember, unlike regular investors, Buffett’s been collecting that 10 percent dividend. He’s still ahead of the game.

Now Buffett is investing in beleaguered Bank of America. He invested $5 billion in a special preferred stock and will be getting a 6 percent dividend, while the regular stock you can buy pays less than 1 percent. Now I don’t know whether Bank of America is a good deal at current prices. Maybe it is. But the point is, if you buy now, you’re not getting the same terms as Buffett. You’re just pumping money into his dividend payment and hoping for the best.”

Source: US News & World Report


So what is an investor saving for retirement suppose to do? Simple, learn about seasonal and timing strategies. And yes, I know that timing the market is impossible – but investing in strong sectors and avoiding the weak areas of the market are not. And it’s not that difficult to do.

One of the models I use in the ARTAIS Fund, is a seasonal model. The seasonal model is based on the fact that markets are historically stronger during certain periods of the year. For example, from 1940 to 2009 the average daily gain from November to May for the Dow was 27 time higher than the average gain for all other days.

The seasonal model I use takes this concept one step further – invest in the strongest sectors during historically strong periods. For example, we are now in a period where gold stocks are historically strong.The Barron’s Gold Mining Index has shown a gain for gold stocks during the month of September 22 times over the past 31 years, sporting an average gain of +5.7%.

The returns have been very impressive for the seasonal model. We backtested the model with the following rules:

  • Invest in the technology sector at the close on the last trading day of October.
  • Sell investments in the technology sector at the close on the last trading day of January and invest in the energy sector.
  • Sell investments in the energy sector at the close of the last trading day of May and hold cash (or money market) during June, July and August.
  • Invest in gold at the close on the last trading day of August.
  • Sell gold at the close on the last trading day of September and hold cash during October.

A simple strategy that beats “justing buying the market”. Lesson here is if you want to retire, stop listening to the Wall Street/Mutual fund marketing machine.

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