Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

3rd Quarter | 2021

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

By Jerry Wagner

From ghoulies and ghosties

And long-leggedy beasties

And things that go bump in the night,

Good Lord, deliver us!

Traditional Scottish prayer

It’s almost Halloween, and we’re still in the middle of a scary period in the stock market. September is known as the worst-performing month of the year. October is the most volatile. Could there be a better time to discuss what frightens investors most—the things that go bump in the night?

The phrase goes back to at least the 1800s, when you can imagine Celtic children kneeling by their beds, praying to keep the monsters away from their homes on the desolate moors. Today the expression is usually used to refer to unusual or frightening sounds you hear at night. More generally, the phrase conjures up flights of the imagination or the unexplained.

Financial news gives investors a fright

Hush little baby,

Don’t say a word,

And never mind that

Noise you heard

It’s just the beast under your bed

In your closet,

In your head!

“Enter Sandman,” Metallica

From my discussions with advisers and their clients, it seems that many have been alarmed by third-quarter news events, expert commentary, and the financial press. Despite stocks hitting new all-time highs in the first week of September, investors were already panicking as early as August, given some of the dire predictions.

For investors, there have been plenty of monsters causing bumps in the night that may make a peaceful sleep impossible. Visions of the delta variant, Afghanistan exit debacle, troubles at the borders, soaring taxes and spending, and runaway inflation sending prices sky-high torment us. Each can stir the mind to imagine all kinds of scary future scenarios.

Investor fears often stem from listening to the constant media screams and howls to which we subject ourselves. Trying to invest by following news events is often a road to ruin.

When I was one of the founders of a hedge fund back in the 1970s, my partners ran the fundamental side of the fund. I invested, instead, using a quantitative arbitrage methodology.

My fellow managers were very good at analyzing the likelihood of passing upcoming congressional legislation. Their strategy was to hedge their part of the portfolio to “take advantage” of the news of the expected passage or defeat when the legislation finally came to a vote.

Their strategy seemed logical. There would always be winners and losers in such an event. And they would buy the likely winners and short the probable losers.

Enter the real world. Rarely did the market cooperate. Like a poltergeist haunting a home, the company shares they bought and sold did the unexpected. They never seemed to behave as “logic” would dictate.

Shining a light in the dark

Things that go “bump” in the night

Should not really give one a fright.

It’s the hole in each ear

That lets in the fear,

That, and the absence of light!

“Bump,” Spike Milligan

In his limerick “Bump,” poet Spike Milligan suggests that fear is often outsized to the source of the noise. That certainly seems to be the case so far.

The current correction has generated barely any decline. At its worst, the deepest drawdown has been 5.5%, which occurred on October 4. Even our 2X leveraged strategies have not declined as much as 10%.

There certainly may be more to come. As I have often said, “Risk is always with us.” But so far, this has been what I refer to as a “baby” bear (short, frequent, shallow market declines of less than 20%), as opposed to a “grizzly” bear market correction (rare, long, deep market declines of 20% or more). The former is just a distraction, while the latter is life-threatening.

Because of this distinction, our investment strategies seek to put up with the “baby” and avoid the “grizzly.” In a perfect world, we would avoid both. But it’s not a perfect world, and there is no ideal market-timing strategy. As a result, we choose to avoid the significant declines and not worry about distractions.

We have demonstrated that avoiding the full extent of the market’s 55%–75% downturns and then participating in the ensuing market gains should be the focus for investors and their portfolios. Due to these major market declines, a buy-and-hold investor in the Dow Jones Industrial Average would have spent only 24% of their time since 1885 in net bullish territory—that is, above breakeven and moving to new heights (38% of the time since WWII).

While the limerick “Bump,” like Metallica’s “Enter Sandman,” refers to letting the fear in through the “hole in each ear,” it attributes fear to another source, as well. It’s not just the noise but also “the absence of light” that lets our fear grow.

Applied to investor fear, I think this references two irrefutable facts. First, investing is a full-time job. Most investors do not have the time for the research and trading that professional investment organizations spend all of their time doing. They like to enjoy life, take vacations, and they want someone who can monitor and trade their portfolios if they become unavailable in other ways.

Second, I think investors acting without a plan are investing in the dark. Lying alone in bed at night or sitting in the darkness can give rise to imaginary fears. But so can investing without a plan. Successful investors know when and why they are buying, and, most importantly, they know before they buy what will cause them to sell.

What’s your goal? Chasing performance or creating wealth?

When investors worry about a 5% or 10% decline, you have to wonder, “What is their goal in investing?” Are they chasing short-term performance? Do they think it’s realistic to expect to buy every dip and sell at every minor top? Or, is their goal to create wealth?

To create wealth, you have to invest in suitable investments but learn to endure the small dips. Trying to sell the small dips usually leads to whipsaws, as the general trend of the market is up. In addition, when you sell, you have to know what will cause you to buy in again. Otherwise, you get left behind and lose valuable investment opportunities for growth.

I think we are in such a time. But if we are not, our investment strategies are designed to become increasingly defensive if this baby grows up to be a grizzly.

What’s next?

As many believed, the bears had everything going for them in the third quarter. All of the news was negative. We were in the part of the year that historically is the market’s weakest.

In response to these market bumps in the night, stocks and just about every other asset class fell. Investor optimism from the spring vanished, and pessimism took its place.

Yet stocks fell only 5.5%. And, as was noted in an article on the Merriam-Webster website, “One consolation is that things that go bump in the night don’t stay long—they make a sound, or two, or three, and leave.”

The scary period will likely persist a little bit longer until Halloween trick-or-treaters have cleared the streets. But in a matter of days, the seasonally weak period for stocks will be over.

The Federal Reserve is still pumping out dollars, despite Chairman Powell’s talk of tightening in December, which means more liquidity for the financial markets. Between now and December 3, an infrastructure bill with even more trillions of dollars of spending is likely to pass, and Congress will once again kick the debt-ceiling can further down the road.

These actions are indeed likely to spur inflation further. But that is also likely to create a once-in-a-generation opportunity in commodities and other alternative investments. We continue to maintain our subadvised gold fund, The Gold Bullion Strategy Fund (QGLDX), and have recently added pure commodity strategies to our subadvised Quantified Alternative Investment Fund (QALTX). And it’s good to remember that stocks are attractive investments because they provide investors with some of the best inflation protection.

Today’s culture is different from the one in which I grew up. It seems to me that it has become less logical. People appear more fearful. Emotions are always running in high gear. What hasn’t changed is that investors and people generally want more certainty, but life is uncertain.

Having a disciplined plan with an investment professional is the best recipe for financial success. Employing quantified, risk-managed strategies in your plan can help quiet the demons that keep you awake at night.

We will never totally quiet today’s major demon, COVID. With the help of all the medical miracles delivered in the last few years, we have to learn to live with it. It needs to become just one of those things that goes bump in the night.

We hear these sorts of things all of the time now. The bumps we have always heard in the night follow us like ghosts into the daylight hours, as well. Yet, as the Allstars’ song “Things Go Bump in the Night” reminds us while Scooby-Doo ventures once more into yet another haunted house,

You cannot run. And you cannot hide.

Yeah, you gotta face it, baby.

Things go bump in the night.

Wherever you run. And wherever you hide.

Yeah, you gotta face it, baby

Things go bump, bump, bump in the night!

Have a happy and healthy Halloween!



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