Keep Calm and Carry On
Igor Manukhov - Nov 29, 2024
Stay invested until the market changes direction.
2024 continues to impress, with increasingly current clients and prospective investors asking me if it would be wise to sell and capture gains. Given how many times I have been asked this same question, I thought I should find a chart to answer it.
First, if you hold multiple assets in your portfolio (i.e., stocks, bonds, cash, etc.), then the stock market rally probably disturbed your strategic asset allocation. For example, if at the beginning of the year your asset allocation was 80% stocks and 20% bonds, and you did not rebalance this year, you are probably now sitting at something closer to 90% equities and 10% bonds. You will want to rebalance your portfolio back to your strategic asset allocation (i.e., back to 80% stock allocation, down from 90% in this example).
You can also raise cash more tactically. Again, using 80% equity allocation as a starting point, you could temporarily reduce your equity allocation to 60% in anticipation of a possible market drop. The real question is: what are you basing this decision on? If you are looking to make this tactical call, you need to have a solid reason, because selling - just like buying - has risks.
Here is how I approach this exercise. For the dramatic effect, I will be using 2008 market crash as an example.
1. I stay invested for as long as the market is in the uptrend.
I do not have a specific target, because the market can go up for an extended period of time and by a lot more than I think. Using the chart below, I stay invested for as long as the market (the black line) is trading above the 30-week moving average (the rising purple line), which representing a longer-term trend.
2. Market trend does not turn on the dime.
It takes a lot of money to change people's mind (in either direction). Remember, every transaction is an agreement on price and a disagreement on value.
3. Historically, major trend changes occur in a 3-stage pattern.
Stage 1 – The market turns sharply lower. This often coincides with some disappointing or shocking news that scares the market.
Stage 2 - When the market goes down, bargain hunters’ step in and start buying, thinking they got a deal and will make a lot of money. This ignites demand for shares, outpacing supply, and drives up prices.
Stage 3 - As prices advance, more and more people start dumping their shares. These are weak shareholders who might not have high conviction in their stock positions. Maybe they missed a previous market peak and are now happy to get out at almost the same price on the rebound. If the supply outpaces the demand from bargain hunters, prices will start going down again. Stage 3 takes the market much lower than stage 1.
In stage three, the moving average (purple line) begins to fall and acts as resistance during rebounds, as opposed to acting as support during pullbacks in bull markets.
I would only contemplate tactical selling when a price rebound fails to break through a falling moving average (green circle). This typically happens at the tail end of stage 2.
I reviewed all bear markets from the early 1960's to now, and in every instance, I observed that it takes three moves to change a major trend. This pattern does not look identical every time, but it is consistently visible on the chart.
Until this pattern emerges, we should keep calm and carry on.
