Don’t Underestimate the Value Of ‘Wait & See’

Even in the best of years, equity markets experience negative monthly returns. In fact, if you go back to 2000, there is only one year when the S&P 500 Index rose in all 12 months: 2017. This means that even in years of above-average performance — such as 2023, 2021, 2020, 2019, 2013, 2009, and so on — equity markets usually fall. In fact, it is common to see 5% monthly declines or more.

Since the inception of the SPDR S&P 500 ETF Trust in 1993, it has experienced a monthly decline of 5% or more 36 times. That averages out to more than one per year. A quick glance at the list of those years with above-average performance years shows they are not exempt from this occurrence either.

Over the years, one of the central tenets of our A Systematic Walk Down Wall Street blog and these Monthly Notes has been to comment on studies that document average investor performance versus the S&P 500 Index. These studies show that investors tend to underperform versus a simple strategy of buying-and-holding a passive index — and by wide margins. There are many possible explanations. A big one, in our opinion, is investors’ inability to decipher between times to hold and times to run.

To counteract this tendency, we turn to the principles of trend following, which we think offer a more rational, systematic approach.

We believe one of the biggest benefits of trend following is its ability to influence investor behavior by applying a disciplined, repeatable process. Let’s explore what we mean.

Good behavior is generally understood as making the right decision among various choices, but as Charlie Munger would say, “Invert, always invert!” Inverting this thought would be saying that good behavior is making right decisions, but also avoiding wrong ones. We think a major benefit of being good at avoiding potentially stupid decisions is that it is arguably easier to achieve and more repeatable than the reverse, trying to be smarter than everyone else.

From our research, selling when a market is in a long-term uptrend but declines a few percentage points is usually a bad decision. Thus, in today’s market, following our rules and staying overweight in equities creates what we believe is good behavior that can benefit our clients. Doing so over and over means we can target performing well over many years, seeking to do so without having to play catch-up or endure the stress of falling way behind.

A sibling (or maybe close cousin…) to behavior is discipline. If behavior is making right decisions and avoiding dumb ones, then discipline is the ability to do that repeatedly in the face of stress, doubt, and outside pressure. We agree with the sentiment captured in the quote above from former Navy Seal and ultramarathoner David Goggins: discipline trumps everything. We think that if you’re following even a subpar investing process, discipline is what fosters compounding, which simply needs time to produce potentially great results. No brilliance necessary.

In our experience, investors often overthink the need to time entries and exits perfectly. They are constantly living in fear of a bear market and looking for reasons to trim exposure or exit when they should be adding to positions. Likewise (though less often), they may look for reasons to buy when they should be reducing or heading to safety. If there is anything we are confident of, it is that the timing matters far less than broadly sticking with uptrends, avoiding downtrends, and doing it consistently.