Recognizing Panic, and Appreciating a Less Volatile Index

I had two questions come in that I thought would be good to answer in a post. The first came into my Street.com email account.

I wrote an article that made a mention of the PowerShares Buy Write ETF (PBP) as being a low vol proxy for large cap US stocks and included this chart to illustrate the point.

click to enlarge

The reader said in his email that YTD PBP was down 7.8% while SPY was down 8.75%. I can't vouch for his numbers but we can assume he is correct. Based on those numbers he said it is not clear to him that PBP offers any advantage with respect to the volatility. I'm not sure I would be so quick to dismiss 95 basis points in three weeks, but I guess that did not resonate with him. The above chart covers two years. As you can see, over the two years the lows are not as low and the highs are not as high: i.e. it's less volatile. However you can also see that for short spells of time, like two-three weeks here and there, it offers no real difference. During a brief bout of crazy market action - I think this month (the past week in particular) counts as crazy - it is very difficult to draw conclusions about too many things. Over a period of a few months there will be some difference and that difference either matters or it doesn't--that is for the individual to decide.

Another reader seems to disagree with the notion of that panicking out Tuesday at the open. You can click here to read the comment as I might be mis-reading him. He starts out with "i don't think it is necessarily panic or foolishness to severely limit one's exposure to the stock market in a highly uncertain time." He also makes a point that I would paraphrase as 'people should respect whatever they had to do to get the money in the first place' and I agree with that completely. He is critical of "this generation" for its willingness to put capital at risk with no guarantee of getting it back. Perhaps a homage to the Will Rogers quote about return of versus return on. Well I think there are a couple of good things to point out. One part of this that I think he is missing, is proper asset allocation. No matter your age, if you are alive 15 years from now, your expenses are going to be 50% higher than they are now. Unless you have $10 million today and only need to spend $50,000 per year (or similar numbers) you need some growth. Only having cash and bonds won't give you the chance to keep up with inflation. If you are 75 and you make it to 90, but you hadn't planned to make it to 90, you will have a problem. I am not trying to minimize the anxiety that stocks create, I know it is real but no matter what anyone's tolerances are, our expenses are going to be 50% higher 15 years from now. That is just how the numbers work.

Another important aspect to this issue is how the stock market works. It has an up year almost 3/4 of the time. It averages about 10% per year which includes all of the booms and busts along the way. Anyone investing a lump some into equities on Friday October 16, 1987 has long since forgotten about that or they would look back and chuckle at the timing. Remember a proper allocation has some portion of stocks, bonds and cash. If someone's target for stocks is 65% and they are close to that when equity calamity hits, they should be able to weather it if the plan was constructed properly. If you put all of your equity allocation into SPY and never make a trade, you'll average 10% over reasonable periods of time. Now, to the extent that value can be added with some sort of well-planned, defensive strategy, thought out ahead of time, all the better and frankly a lot of ink is spilt (intentional mis-spelling) on this blog on trying to add value/smooth out periods of down a lot. And with all due respect to the reader, if he is green-lighting selling stock into a sheer panic, that strikes me as the exact opposite of how to navigate markets. V-shaped declines and their subsequent snap-backs happen more often than bear markets, and it is during the V's where the biggest mistakes get made, because they create the most emotion.

The rolling over from October to year end was the time to make changes (I feel my past blogs from that period give me the credibility to say that now). The start of this bear market, assuming that's what it is, was very typical. The current panic, that seems to have subsided, may be a little atypical. But recognize the beginning of the week for what it was: panic.