EC A Style-Based Approach To Market Meteorology

Where is the stock market going? Up Down? Sideways? We devote considerable time and resources to seeking answers despite the reality that few among us, if any, can give consistently reliable answers to such questions. Perhaps it may be more productive to accept the role of equities as a core investment asset class and ask, instead, what kinds of stocks may be preferable given readily observable market weather conditions.


Re-thinking Age-Old Questions

On October 12th, I posted an article suggesting it was time for conservative investors, who had been left in the dust by the growth-momentum market leaders since late 2016, to anticipate a shift toward a more respectable view of risk control. Was that an accurate “forecast?”

I wouldn’t be at all surprised if it were the case that many, at least subconsciously, read between the lines to discern whether I was giving a bullish or bearish forecast, or that others took umbrage at what seemed to them to be an effort to chicken out of taking an actual position with regard to the market’s future direction. It’s easy for anyone to read into such a post whatever suits one’s wishes.

The harder thing to swallow, however, may the possibility that I really meant exactly what I said: “[T]here’s a big difference between saying ‘sell stocks’ versus saying ‘hold stocks and even buy more, but consider pulling back a bit on the degree of risk you take.’ I’m not saying the former. I am proposing the latter.” No hidden messages. No subtle hints. Just straightforward message to stay with stocks but switch to those that rate higher in such areas as risk reduction, quality and so forth.

Was I right to suggest such a course? 

Well, had you simply sold everything instead of reconfiguring to a lower-risk profile, you’d probably be ahead of the game right now since the market continued to slip. But that’s not really the answer. The market is like a book that keeps going on and on and on with no final chapter in sight. (Game of Thrones? Did that ever end? I lost track.) Just because one who wished I said “Sell” would see that post as having been wrong, that doesn’t mean it will look wrong a year or two down the road. See, e.g., the many who sold into the 2008 crash (and others before it) but failed to get back in, if at all, until long after the market passed its pre-crash high. It’s a lot easier to dream about getting out and in at the right times than it is to actually do it. And actually, as we’ll see below, the advice to trim risk was, at least so far, prescient. 

There is, of course, a passive alternative: Just buy an index that represents the whole market and cease and desist from thinking about it. Assuming you can pull that off while pretending that your active choice of which among many available indexes to track was somehow passive (even the old standby, the S&P 500 is, whether one wants to admit it or not, an active decision to invest in large-mega-cap generally high-quality U.S. equities), that may not be the most prudent course of action. Notwithstanding the efforts of those who make their fortunes by selling books trying to convince readers that the market can’t be comprehended, the reality is that there is much that can be seen, even by ordinary mortals looking at readily-observable observable here-and-now circumstances, and it hardly seems prudent to ignore obvious risks in favor of blind allegiance to promotional or marketing mandates: As we learn from Kurt Vonnegut’s dystopian 1950 short story Harrison Bergeron (part of his Welcome to the Monkey House collection), a human brain is a terrible thing to waste. (It’s a really good story and I heartily recommend it).

harrison bergeron

Those who view equities as a core investment asset class are not likely to go from 100% invested to zero invested and back and forth again and again. The usual course of action is to adjust exposure according to one’s sense of the market’s temperature. (Even the folks who go on TV and speak in bearish terms are not likely to sell all stocks, but are more likely to adjust the weight of their equity exposure (viz., say, fixed income) and/or reallocate from some kinds of equities to others (e.g., sector rotation or style rotation)

Market Meteorology

Taking the market’s temperature, measuring its atmospheric condition, etc. is not at all complicated. We can glean a lot of information simply by studying various logically-related pairs of style-specific ETFs, one representing a high level of exposure to a specific style and the other representing the stylistic opposite.

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