Friday, August 5, 2011

Reason over passion

The carnage in the markets on Thursday was truly breathtaking. By the time the European markets closed, it was clear that there was nowhere to hide in the US.

The broad based US stock market averages were down 4-5% on the day. "Defensive" sectors such as utilities, consumer staples and healthcare were down -3.3%, -3.2% and -4.0% respectively. While the returns of these sectors outperformed the averages, it was cold comfort to investors who lost 3-4% in a single day.

What about gold? Aren't we told by the gold bugs that it's the only "real money" and the only source of stability in a crisis? Oh, never mind...

In the words of Dennis Gartman, Thursday was the example of a "margin clerk market", where everything was liquidated to meet margin calls or to de-risk portfolios. The only green on my screen were bonds and bond ETFs.

Do you have a credible plan?
To be a successful investor, you must have a disciplined and credible plan and you must follow it during these periods of market turmoil. I have a plan and it's called the Asset Inflation Deflation Timer Model. I rely on it to be tactical in asset allocation and the Timer Model designed to make money in sustained bull markets (by buying risk) and sustained bear markets (by buying long-dated Treasuries).

To put the weakness into context, equities are down slightly over 10% on a peak-to-trough basis. Although short and dramatic, this recent bout of market weakness puts it into the category of a plain vanilla correction.

While I remain concerned about the risk of financial contagion in Europe and a double-dip recession in an already weakened US economy, I am relying on the discipline of the Timer Model to stabilize my portfolio during periods of extreme stress, e.g. a Russia or Tequila Crisis. Otherwise, I could be panicked into making self-defeating decisions at precisely the wrong time.

Do you have a credible plan and are you following it?

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