The Risk of Missing a Reentry When the Market Turns

 |  Includes: DIA, QQQ, SPY
by: Roger Nusbaum

I found this article by Nouriel Roubini on the Foreign Policy website (hat tip Alphaville). It outlines why various regions in the world will feel the US' pain, especially if the recession lasts four quarters or more.

The quick take is that everywhere will be hurt but that a couple of places will, in addition to being hurt, will also derive a touch of benefit.

A reader left a comment yesterday saying he might chuck it all and go into GLD. If you read a lot from Roubini you might be inclined to do the same.

If you have been reading this site for a while, you know where I have stood for months - normal bear market without pieces of sky hitting the ground - but of course I could be wrong. If you are inclined to chuck all your equity exposure, you need to explore and understand the other side of that trade, know the risk you take in doing that, and have something reasonable in mind for how you make up for normal equity market growth.

Sticking with the normal cycle idea (which the risk faced by the chuck it all idea), if this turns out to be normal it is very likely that the first year off the bottom will be huge, like 2003. How many people do you suppose finally gave in in 2002 and did not catch 2003? There is no way to know, but we can know that a lot of people did sell in 2002 as it was the worst of the three year decline. This decade has had a lot of down followed by many years now of up, but anyone completely missing 2003 (or a large chunk of it) has likely missed too much of what little up (in percentage terms) there has been.

This is how people come to lag the markets in all those studies we see quoted. When the bottom comes and the market turns, it is likely to be a big bounce. This has held up historically in all manner of declines (long bear markets or nasty V shaped events). The way this decade is shaping up, missing 2003 could be the difference between being even on the decade or down a lot. Likewise anyone missing 1975 (up 31%) made the 1970s much worse than it needed to be and anyone missing 1934 (up 40%) made the 1930s worse than it needed to be.

Anyone reading this site for a while knows I am all for defense and underweight, but the risk of zero weight and missing the best year of a decade can be very bad. The market averages 10% (or whatever the exact figure is) by going up 40%, down 40% and everything in between. I can't stress enough that missing one of the big years in a decade can leave you so far behind as to alter your financial future.

Lagging an up 40% year however is a horse of a different color.

This is not a bet I would make, and anyone entertaining that sort of a bet needs to understand the consequence of missing a reentry.