The title of this article might make you wonder if the market will tank and the answer is yes. The market is going to tank. The real question is, when?
First, let’s clarify what we really mean when we say “tank.”
Tanking is not a loss of 10 or 20 per cent, although no one is happy when they lose that amount. True tanking is a 40 to 60 per cent loss–the type of losses the market has, and will continue to have, every five to seven years.
Examining stock market history, you can see how the market goes straight up for a particular period of time (again, five to seven years) and then suddenly, your portfolio seems to drop like a hot potato. This has happened so systematically that it makes the market seem like a well-oiled, broken machine. It seems like an oxymoron.
But let’s just go with it and not fight it. Accept that this happens and move on.
If you accept this fact, doesn’t it make sense to have some kind of strategy to get out of the market before it drops?
Using technical information about the market, you can draw some conclusions about when the market is so overpriced and out of control that it is about to drop precipitously.
Here are some technical analysis tools that you should keep your eye on:
Momentum. What is happening with market prices in comparison to the 200-day moving average or the 10- or 12-month moving average? Look for the time when prices break through the 200-day moving average, because that is a bad sign. When we experience a market like 2000 to 2002, or 2008 and 2009, the averages started showing weakening signs very early in the down trend. As a matter of fact, simply using momentum, you could have averted the entire debacle of both of those down cycles, if you were looking.
Yield spreads. Watching fixed-income spreads is extremely important. Fixed-income traders typically get it right when it comes to investing. They often see a down trend before anyone even starts looking. Their conservative nature is the reason. As the market begins to show signs of weakening, fixed-income traders will begin to pull out of riskier bonds, such as high yield, and go into safer bets, such as government bonds. At that point you will begin to see a larger disparity between the rates on those two kinds of assets. This could signal a move on your part.
Volatility. As investors get nervous, they begin to hedge their bets with options. Option pricing can tell you a lot about what is happening in the stock market. The way to measure volatility is to keep an eye on that option pricing by looking at the VIX, the Volatility Index, also known as the “fear gauge.”
Correlation. When riskier assets get sold en masse, the correlation of those various assets begins to move closer together. Assets that would historically move in very different directions begin to move together in almost lock step. This is a bad sign and you should think about making a move.
While this looks like a great strategy, it is not fool proof. Don’t make a move when one or two of these measures show signs of decline. Look for all four to be pointing in the negative direction at the same time. You may even want to wait to see if that decline happens for two months to rule out false positives. The point is to always be looking.
When talking about an ‘evacuation strategy,’ it’s interesting how often people will say, “That’s market timing, that won’t work.” Maybe it is and maybe it isn’t, but the question you should be asking is, “What do you have in place to keep your portfolio from losing half its value every six years?”
Having a strategy is the key.
Good luck and happy investing.