Most Dangerous Stock Market of All Time Requires a Systematic Approach

By some measures, this is the most dangerous stock market of all time. Traditional technical and fundamental analysis are seriously limited in this new environment. A systematic approach could offer some protection when normalization begins.

In the not so distance past, and I am referring to pre-QE era, economic, political and geopolitical developments would cause swings in prices, often significant. Nowadays, everyone is almost convinced that normal events no longer affect prices and only a black swan can cause a trend reversal. This perception has been reinforced in the last 9 years by central bank actions and corporate buybacks. The message to investors has been to not worry about any adverse development in the world, such as tensions with Russia, China, trade and currency wars, rise of extremes in Europe, Brexit, etc., because prices will be driven up eventually by insiders and central bankers.

I will just give an example of how this new dynamic of supporting prices at any cost has fooled even astute investors. On June 27, 2016, Jim Rogers asserted that Brexit would result in “Worse than any bear market you’ve seen in your lifetime” and it will be more severe than the 2008 crisis. Instead, we saw markets shrugging off the result and moving higher. It appears that Jim Rogers’ analysis was based on old dynamics of markets rather than this new condition where nothing really matters except a black swan.

After the 90s bull market, the stock market became mean-reverting delivering two devastating bear markets with drawdown of about 50%, enough to cause uncle point to majority of non-sophisticated market participants and investors near retirement. Another bear market of this magnitude was carefully averted by central bank intervention and corporate buybacks especially during the twin correction of late 2015 – early 2016. The predominant perception now is that nothing can cause a bear market except a black swan because central banks and corporations will support prices.

Needless to say, for the above reasons this is the most dangerous stock market of all time. Portfolio diversification is necessary, especially with alternative products that benefit during equity market turmoil, such as commodity futures programs and long/short equity. However, the most important aspect of a methodology is systematic trading. Very little from the technical or fundamental side works nowadays due to the persistent uptrend. Investors and traders need to adopt a systematic approach and follow it otherwise erratic actions and decision can cause more damage than price action itself.

Towards this end we are constantly updating our systematic strategies. We now have one adaptive trend-following strategy and one mean-reversion strategy for SPY, two ETF rotation strategies, one mean-reversion strategy and one long/short strategy for Dow stocks, and one long/short strategy for FAANG stocks, for a total of seven systematic strategies. We believe that this mix may provide enough diversification to deal with a future market reversal and turmoil.


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