Every year in December, Dorsey Wright, one of the primary services we subscribe to for information, details some of the concepts we use to manage client portfolios called “The 12 Days of Christmas.” Much of the discussion is available for public view and is incorporated in one of the videos on our Petra Financial website. You can view the concepts in their entirety on our website by clicking this link: We Are Not Your Old Stock Broker. I will highlight the concepts individually over the next 12 months.
We will begin the series today with a discussion of market structures and the importance of tactical allocation. A long-term perspective of the Dow Jones Industrial Average (DJIA), since 1896, reveals the reality that there are extended periods of time in which the US Equity market will trend generally upwards and also lengthy periods of time where the market will instead stagnate or move generally lower. There have been eight such alternating cycles completed since 1896, with each averaging fourteen years in duration. On its own, this is not earth-shattering information; however, the application of this concept to investing is integral to the importance of tactical strategies.
Consider this, let's say an individual begins to accumulate meaningful wealth with which to invest around the age of 40. Assuming an average life expectancy around 80, the individual should plan to endure three of these cycles during his or her investing lifespan. The unknown, of course, is whether the investor will see two bull markets and just one bear market, or be faced with two bear markets and only one bull market. In short, where an individual gets on the “investment train” can have a tremendous impact on portfolio returns overtime; however, even an individual fortunate enough to see two bull markets needs a game plan to navigate a potential 14+ years' worth of a bear market. It is important to have at one's disposal strategies that are effective in both generally rising (bull) markets and falling (bear, or "fair") markets.
"It is important to have at one's disposal strategies that are effective in both bull markets and bear markets."
One methodology that has existed since the late 1800's and proven effective in both kinds of markets is Point & Figure. One of the first proponents of the methodology was Charles Dow, founder of the Wall Street Journal. Although a fundamentalist at heart, Dow appreciated the merits of recording price action in order to understand the changing relationship between supply and demand in any investment. The Point & Figure Methodology has evolved over the past 100+ years but at its core it remains a logical, organized means for recording the supply and demand relationship in any investment vehicle. As both consumers and investors, we are innately familiar with the forces of supply and demand. It is the first subject introduced in any economics class, and we experience its impact regularly in our daily lives. We know why tomatoes in the winter don’t often taste particularly good, have a short shelf-life, and are paradoxically more expensive than those sent to market in July. What many investors are slow to accept is that the very same forces that cause price fluctuations in a supermarket also trigger price movement in the financial markets. In a free market of any kind, if there are more buyers than sellers willing to sell, price will rise; when there are more sellers than buyers willing to buy, price will fall. If buying and selling are equal, price will remain the same. By charting this price action in an organized manner, we can ascertain who is winning that battle, sellers or buyers (i.e. supply or demand). By having the ability to evaluate changes in the market we have taken the first step toward also becoming responsive to both bullish and bearish periods.
Until next time, cheers!
Jim