Just Follow the Trend

Buy and hold. Stocks for the long run. Diversify. These investment mantras were gospel during the great bull market of the 80s and 90s.

Drinking this Kool-Aid will get you slaughtered today.

There is no freaking way I would "buy and hold" anything right now. It is way too dangerous. Buy and hold hasn't worked over the past ten years, and it's unlikely to work for the next ten. We're in a secular bear market, and these things take time - usually 15 to 20 years - to run their course.

Buying and holding the S&P over the past 10 years didn't work out too well. (Source: Google Finance)

No doubt, we are in uncharted financial waters right now. Anyone who says they 100% know what's going to happen next is lying, or delusional.

We've got historic deleveraging taking place, as unprecedented debt levels are slowly paid down. In the meantime, we've got the US government, among others, running the printing presses at full steam, and tossing boatloads of money down rat holes like Government Motors and socialized medicine.

The foundation of the system has been permanently rocked, and stability, or even just the illusion of it, won't be back anytime soon.

With the Fed's printing press (an irresistible force of hyperinflation) battling massive deleveraging (an immovable deflationary object), the crux of any investment thesis today starts with "inflation or deflation?"

There's no shortage of arguments on both sides, many made by folks much smarter than I. For awhile, I was reading them until my head spun. First I'd read a very well thought out argument on why hyperinflation will win out, then I'd read a perfect counterargument for the deflation case.

So I thought - what the heck can a guy like me do, if these smart dudes can't reach the same conclusion themselves?

Then it hit me - trend following.

If gold and commodities go up - get in those vehicles, because the market is screaming "inflation"! Gold at $1100 could go much, much higher - real, real fast.

On the other hand, gold still has not decisively broken through $1000. It could very well retest its lows below $700. So if it breaks down below, say, $900, that's the market telling us that inflation is not in the cards...at least not yet.

Early last week, gold stocks hit a 3-week low, so I sold all of them. And I'll stay out until they once again "break out" to the upside. That's the only way I can see to play these insane markets - buy the breakouts and follow your stops. It's OK to have a hypothesis, but don't wed yourself to it. If the market says you're wrong, then you probably are.

My friend Brian Hunt (editor-in-chief of The Daily Crux, an excellent investment website) made a great point to me on Friday about investing in China. Nobody knows what's going to happen in China. Some think it's a trainwreck waiting to happen. Others think China will be just fine, still the growth story of the 21st century.

So what's an investor to do? Watch the price of copper, he says. As long as copper's doing fine, that means China's doing fine. Let Dr. Copper show you the way.

To facilitate my trend following strategy, I've pared my investment assets down significantly. I used to own 40-50+ different stocks, a few currencies and a few commodities; if something looked good in one of my many newsletters, I bought it.

Then I learned during the Great Deleveraging of '08 that diversification does not prevent bad things from happening. Overnight, the correlation of almost all assets went to 1, and everything dropped 40% in a matter of 6 months.

Because I believe the inflation/deflation question is the only important one, I only need a few asset classes to play it. That makes trend following much, much easier for an armchair investor like myself - get into positions and back out quickly - no problem.

Remember the market is the judge and jury combined; the final arbiter of your investment decisions. So let's listen to what it's telling us in the turbulent years ahead. After all, the trend is our friend! And this friend may be our only lifeline to investment survival right now.

Comments

[retiredengi...:]

No one knows the future. I'm with you and just follow the slope of the SPY 30 day moving average. If its up then buy and keep raising the stop. If it's flat or down then wait. Last year was mostly waiting as was the first quarter of this year. Now again it's flat so time to wait and see. If this week is down I expect much more waiting. Something a retired person can't afford not to do.

Jun 22 09:51 AM

[ain't no fo...:]

I was never a "buy and hold" investor. My best $$ got made by position trading, which I define as getting into a position at a key technical level with fundamentals at your back and riding the breakout for 2 to 4 months... then get out. If it doesn't pop after a short time, get out and look elsewhere, and if it drops 6-8%, get out with the small loss and live to fight again.

The events of August 2007 and onward shortened up my perspective dramatically and I wisely (humbly and in retrospect said) stayed VERY short term, took smaller positions, didn't carry a lot over night and ran at the first sign of trouble. It saved my butt.

I still believe that is a good strategy for this critical time in the markets and think we have a major test coming up by late summer/Fall.

That said... we are a nation of shoppers, and 70% of our GDP is currently based on retail. We have seen a massive, unparalleled collapse in asset wealth... the great driver of economic prosperity, our middle class, is terribly wounded - so what difference really does hyperinflation or serious deflation really make at this point? Either way, our purchasing power will go down, because things will get ridiculously expensive as our dollars buy less or because we will have less $$ to pay for goods - so yes, flip the coin.

Heads we lose.
Tails we lose.

Jun 22 12:49 PM

[Alan Young:]

Trend following works fine when there's a trend (e.g. this past March). But then there's a consolidation (most of April-June). So unless you trade intraday trends, you either hold on and hope for the best, go to cash, or ... trade the oscillators (beyond my skill, personally).

So I agree with your premise, but not your conclusion.

Jun 23 07:50 PM

[User 474371:]

Why are we such suckers for prediction?
I think we love predictions because if we make predictions, and/or concoct explanations for those events we predicted wrong, then we won't feel like victims of randomness. We feel more in control. But are we more in control or just intoxicated by some illusion of control?
While the lack of clear trends is hurting, trend following has worked in the past and will perform into the future for a simple reason: trends exist and they can be traded up and down for profit. You cannot make a profit if you are opposite the trend. Discipline and patience are required to succeed. The trends will inevitably return.
ViewpointsOfaCommodity...

Aug 21 10:36 AM