Twenty years ago I visited my father in Florida. He had worked on Wall Street during the Great Depression and had been a businessman and active investor for almost 50 years.He took me into his office and opened a large book of charts. He pointed at a thin red line running across one of the charts that stretched for decades. He said it was a composite moving average of all the mutual funds in America.
"When the market moves above that red line, I buy a couple of all-purpose mutual funds from a list and hold em'. When it goes below it, I sell. And I don't get back in until it rises above it again. I've tried many things in this game, but at the end of the day I've never found anything better than this. And remember, there's no such thing as buy and hold for the long term. It doesn't work that way."
Twenty years have gone by and his simple advice has outlasted every other strategy I have tried (and I've tried many). Which leads me to that thin red line on his charts, or what I've come to know as the Big Picture, the 300 day moving average of the SPX. The stock market follows this index religiously, and the red line indicates whether a stock market is in a bear or a bull mode. The American companies that comprise the S&P 500 are a good barometer of the underlying economy.
Here's how to grasp the simple logic of the S&P's 300 day moving average. A worldwide army of investors and analysts wake up each morning and haggle over the value of the S&P's 500 publicly-traded companies. Billions of shares are traded back and forth. It's a huge foment, and trading continues throughout the day and into the night via the futures market. For the next 300 days - 18 consecutive months - trillions of shares exchange hands as investors seek a fair price ($) for the stocks in the index. The average of those previous 300 days is the number we seek. As Warren Buffett says, "In the short term the market is a voting machine, in the long term, it's a weighing machine."
Over the course of 300 days, the direction of the S&P relative to its long-term average becomes clear. In a bull market, the SPX 500 is consistently supported by its 300 day moving average and rises above it. In this scenario you buy - or hold - the dips.
In a bear market, the index will break below the 300 day line dramatically and continue to drop precipitously in the weeks ahead. The safest strategy therefore is to be in the market only when the SPX is above its 300 day moving average. Avoiding the catastrophic losses of a bear market is extremely important, because the money you save will be available for the next bull market.
Let's take a look at this methodology for 10 and 15 year returns. Using this strategy, a dollar invested in 1999 would be $1.79 today (March 21, 2009), resulting in a 79% return with a compound growth rate (CAGR) of 6%. There would have been two exchanges from funds into cash: in September 2000, and January 2008. For three of those ten years (1999-2009), the capital would have sat safely in cash while financial storms raged around it.
If that same dollar had been invested in a buy and hold strategy, the 10 year return today would be a whopping minus (-39%) loss on original capital. The difference between the two methods is a ratio of 3 to 1, or put another way, one investor lost 39% while the other gained 79% from 1999-2009. 15 year returns are better. A dollar invested in 1994 is $3.78 today - a 278% return with an 11% CAGR. The buy and hold return for 15 years is 64%, with a CAGR of 3.3%. The difference in total return between the two methods is 6 to 1. This is the importance of timing entries and exits along the 300 day line. The when is as important as the what.
What to buy?
Closed-end index mutual funds (ETFs) offer the best safety and the lowest fees. They are very liquid and trade just like stocks. When you buy one of these funds you are buying the general market, the whole list, and are diversified across all sectors.
80% of all money managers perform in line with their benchmarks (their goal) - the large indices - such as the Dow Jones Industrials, the SPX 500 or the Nasdaq 100. But another 10% under-perform them, so you've only really got a one-in-ten chance of finding a financial genius who will beat an index-based system in any given year.
Here's some of the index ETF ticker symbols: SPX 500 (SPY), Dow Industrials (DIA), Nasdaq 100 (QQQQ). If you'd like more leverage on the upside, you could choose one of the Proshares Funds: Russell 2000 Small-Caps (UWM), Nasdaq 100 (QLD), SPX 500 (SSO), or Dow Industrials (DDM). There is also the ability to diversify globally in emerging markets (EEM) and overseas country ETFs.
The average holding time for a bull market is 34 to 44 months, so you might glance at the S&P's 300 day moving average once a week during that time (if that's too much for you, you shouldn't be doing this in any case).
As the years roll by, as surely as summer moves into autumn, the news media will one day warn you of storm clouds on the horizon. The SPX will suddenly fall below its 300 day moving average. Alarms will sound - be explained away by cooler heads - and then re-appear. When that happens, GET OUT, stay out, and wait til the coast is clear.
So often in investing, what you don't do counts for more than what you do. Former Intel CEO Andy Grove once said, "Only the paranoid survive". Preserve your capital. The punishing thrall of a bear market is something to avoid at all costs. But when the storm is passed and the coast is clear, it will be time to begin investing anew. Like springtime, the tide will have turned. There is something miraculous in that.
"There is a tide in the affairs of men,
Which, taken at the flood, leads on to all good fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat;
And we must take the current when it serves,
Or lose our ventures."
Brutus, Julius Casear, Act IV Scene III: From Within the tent of Brutus
August 4, 2011 Note: The SPX 500 crossed above its 300 day moving average on August 4, 2009 at 1,000. It crossed below it again on August 4, 2011 at 1,225. Adding the adjusted returns for the additional two years (2009-2011), the methodology yields a 118% return for 12 years with a CAGR of 6.7%. For 1994-2011, there's a 483% return and a CAGR of 10.93%. Buy and Hold for 1999-2011 remains negative (-2.5%) and for 1994-2011 the return is 160% with a 5.8% CAGR.
