A singing bird was confined in a cage which hung outside a window, and had a way of singing at night when all other birds were asleep.
One night, a bat came and clung to the bars of the cage. The bat asked the bird why she was silent by day and sang only at night.
“I have a very good reason for doing so,” said the bird. “It was once when I was singing in the daytime that a fowler was attracted by my voice. He set his nets for me and caught me. Since then, I have never sung except by night.”
The bat replied, “It is no use your doing that now when you are a prisoner. If only you had done so before you were caught, you might still have been free.”
What you just read is an old Aesop fable called The Caged Bird and the Bat. You may have heard me quote from it before. The reason I do so again is because the moral, or lesson, behind the fable is something every investor needs to consider, especially right now.
What is the moral? Here’s how I would put it:
Precautions are useless after a crisis!
You probably know that the markets have enjoyed a very strong year. As of this writing, the S&P 500® is up over 8% (http://quotes.wsj.com/index/SPX) for the year. The same is true for the Dow®. In fact, the markets have been on a tear ever since the elections last November, in what many pundits are calling a “Trump Bump” or “Trump Rally.”
And that’s a good thing! It’s always nice when the markets do well.
BUT. (And there’s always a “but.”)
When speaking with investors, I often run into people who want to be extremely aggressive in chasing high gains. “The markets are doing great!” they say. “Now’s the time to make a lot of money!”
Unfortunately, the sad truth is that when the markets reach record highs, many investors become irrationally exuberant and make the classic mistake: instead of buying low and selling high, they do the opposite. They become lulled into a false sense of security.
Make no mistake, it’s exciting when the markets do this well. But that excitement is an emotion, and investing based off emotion is always a one-way ticket to trouble.
Now, before we go any further, let’s stop for a moment and agree on what I’m NOT saying. I’m NOT saying you should feel worry, or fear, or any other negative emotion. I’m NOT saying the markets are going to drop tomorrow.
Here’s what I am saying:
When’s the best time to buy a home-security system? Before a break-in. When’s the best time to check your blood pressure? Before you start having chest pains. When’s the best time to put your seat belt on?
You get the idea.
This whole philosophy of taking precautions before a crisis is why we at Wealth Advisors use technical analysis to follow patterns in the market – so we can spot negative trends and act. Another reason this philosophy is important is because while it’s relatively easy to figure out why the markets are doing well, it’s very hard to predict what will make the markets do poorly.
To see what I mean, let’s examine the current market euphoria. More specifically, let’s ask ourselves, “Why are the markets doing so well?”
The answer is that it’s probably a combination of factors. Our country’s unemployment rate continues to do well, having hit a 10-year low of 4.4% back in April (https://data.bls.gov/timeseries/LNS14000000). Many investors continue to be enthusiastic about the prospect of corporate tax cuts and deregulation, two policies that both President Trump and a Republican Congress have championed. In addition, many companies are reporting strong earnings, making them attractive for investors. Finally, sheer momentum could be playing a key role. The fact is, we’ve enjoyed a long-running bull market for years now, interrupted by only the occasional bout of volatility.
See what I mean? It’s easy to explain why things are going well in the present.
But what about predicting what will go wrong in the future? That’s harder to do. Sure, it’s easy to come up with possibilities. Maybe Brexit will bring on the next bear market. There are a lot of questions in the air about how the separation between the UK and the European Union will affect trade, scientific research, or currencies.
Speaking of trade, maybe it will be our own trade policies. President Trump has repeatedly threatened to back out of or renegotiate trade deals (including NAFTA). What if he goes too far, and a trade war breaks out? Or maybe it will be Congress. Maybe Republicans won’t be able to deliver on all the tax cuts and deregulation they’ve promised. Maybe it will be a new housing bubble. Our neighbors to the north, Canada, are currently stressing about a dramatic rise in housing prices, and what will happen if prices suddenly drop. Could the same happen here?
The point is, it could be any of these things, or all of these things, or none of these things. We won’t know until after it happens. Pundits and politicians and analysts will all make educated guesses, and someone will probably be proven right. But we can’t know. Even technical analysis can’t help us know what will cause the next bear market.
It will only help us spot the next bear market before it gets too hungry.
That’s why it’s so important to start preparing now.
So, what have we covered so far?
- The markets are doing well, and that’s great.
- At some point, however, volatility will return. Maybe it will be nothing more than a brief correction, or maybe it will be a full-blown bear market.
- Since we know that precautions are useless after a crisis, we must start preparing now.
What do I mean by preparing? Well, here’s what my team and I are doing.
Traditionally, most investors (and their advisors) use a methodology called “buy and hold.” They create a pie chart showing how they want to allocate their funds, and they stick with it for long periods of time. The problem with this is if a bear market comes during that period, no pie chart will be able to protect you.
That’s why we use technical analysis to help us analyze market trends. Is a particular investment, asset class, or the market as a whole trending up, or is it trending down? We also put in place a series of rules to determine at what point in a trend we decide to buy, and at what point we decide to sell. For example, if an investment trends down below a certain price, we follow “the rules” and sell. Period. If an investment trends up above a certain price, we buy.
That’s what we’re doing right now: closely scrutinizing the markets for trends and patterns. Instead of just basking in the fact the markets are high, we’re on the lookout for storms on the horizon. We’re constantly monitoring the investments within our clients’ portfolios. Instead of sticking with a static pie chart, we’re prepared to reallocate client funds as often as necessary, depending on market conditions. That’s how we’ve helped clients avoid previous downturns—including the Big One back in 2008.
In other words, we’re taking precautions before the crisis—whenever that crisis may come.
I consider it a major part of my job to help people prepare for the future. The markets are doing fantastically well right now – which means now is the time to prepare for when they aren’t. The point of this letter isn’t to cause alarm, but rather awareness. By being constantly aware of potential bumps in the road, we can do a better job of handling them when they come – keeping you on a straight path toward your financial goals.
In short, enjoy the current market highs we’re experiencing. But don’t allow yourself to get complacent. Instead, I recommend being hyper-vigilant and prepared.
If you ever need help with preparing for the next bout of market volatility, please feel free to call me at (719) 630-0600. In the meantime, always remember my team and I are here—both when the sun is shining, and when it’s time to pull out an umbrella.
Building Your 2nd Half,
