When you pull up a long-term chart of the S&P 500 (SPX) going back to the 1960s, it may not look like this one. What we have here is a log scale chart. This is a simple way to visually remove the effect of compounded growth and keep all the movement within a visually normal range.
This study shows us the difference between buy-and-hold (in orange) vs. only owning when the market is above its 50-week average price (blue).
The end result isn’t very different, but the ride is quite smoother when you have stepped aside prior to the extended bear markets.
Something interesting about this is that, even though the result looks attractive, the win-rate (percent of times the filter is right for getting out), is less than 40%.
That means most of the time you see this filter turn on, you will re-enter the market at a higher price. That notion is difficult for many traders and investors to accept. A unique perspective we have is that we aren’t worried about being right “most of the time”. We want the best experience “over time”.
Preservation of capital is extremely valuable for investors. When investments tank, net worth follows. When net worth declines, your options become limited and buying power diminishes.
We believe it’s best to avoid predicting what the markets will do. Simple and effective filters like this are the types of things we look for to help reduce risk and stay in the game.