Time for Active Management
Most stock portfolios today are manged with a "buy and hold" philosophy — what is called passive portfolio management. Your portfolio is managed to replicate an index such as the S&P 500 and that's all. Most investors didn't really choose that approach, but here they are, usually by default, and too busy to think about it.
Given today's extreme valuations and growing market instability, the timing of this shift couldn't be worse, and is likely to end badly. Sadly, the "buy it and forget it" approach to investing for retirement is actively enouraged by the Federal Goverment, financial academics, and, of course, by the giant Wall Street firms and, most likely, by your advisor.
Tracking the
Big Ten
The mechanical imple-mentation of passive portfolio strategies has created poorly understood feedback loops that amplify the market value of the very largest mega-cap companies.
This group of $trillion-plus market caps (the Big Ten) substantially dominates retirement portfolios. And yes, they've done extremely well for the last ten years, but that is unlikely to be the case for the next ten.
The growing disconnect between price and value for these issues will eventually become a threat to the viability of the financial system. Really.
Your investment strategy needs to manage this threat . . .
The KP Trend Model shifted to Yellow as of the close on Tueday, July 28.
Historically, the Yellow color has occupied 34.5% of the roughly 7000 market days over the past quarter century. Those Yellow periods generated average anualized returns of 8.5%, with volatility of 21%, and a Sharpe Ratio of 0.40. OK, but not great.
In the way of contrast. the Green environment, which characterizes 54.5% of all trading days, produced an average return of +18.5% (again, annualized), vol of 12.7% and a Sharpe Ratio of 1.46.
Given these long-term stats, we respond aggressively to any trend condition other than Green. Our active large-cap portfolios ("10x10 portfolio,") for example, reduces equity exposure by 50% on a model shift to Yellow, leaving 50% in cash equivalents.
Looking for the Next Black Swan
The performance of your retirement portfolio is dominated by market trends, not by individual investments.
Yes, equity markets have generated positive returns over the long term, but they also deliver unpredictable and highly disruptive crashes. These events severly impact long-term performance. More important, they usually trigger highly counter-productive reactions from investors and their advisers.
Defending against Black Swan events is a complex and challenging undertaking, as we would expect when so much is at stake. Still, even a partially successful effort to identify precursors of the next major crash will significantly reduce your portfolio's vola-tility and its exposure to a significant drawdown.
