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Locked: Are you ready for the next market crash?

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Sr. Member
Mar 13, 2009
781 posts
212 upvotes
Maple

Are you ready for the next market crash?

I came across an interesting interview from Kirk report (requires subscription, $100/year):

Q&A With Mebane Faber - http://www.kirkreport.com/membersonly/2 ... ane-faber/

Faber is a portfolio manager who focuses on quantitative investment strategies.

Here are a couple of my favorite lines from the interview:

Kirk: In your opinion, what is the most important lesson you’ve learned so far?
Mebane Faber: The real pain of losing money. I don’t care how many times you’ve read Mackay’s or Zweig’s books, you don’t know what risk is until you feel the very real pain of losing money.

Kirk: Very interesting Mebane, especially concerning the issue of volatility and sentiment during the inevitable bear markets we have seen.
To make the point clear, however, the bottom line is that in your view we won’t have an “all-clear” signal for knowing when to get 100% long the market again until we see the S&P 500 close above its 10 month moving average. Is there anything you can imagine that would force you to ignore this signal because you thought a whipsaw as at hand instead?
Mebane Faber: Let me back up and say that this isn’t some sort of Holy Grail or something that predicts where the markets are going. It is mainly a method of risk management and avoiding a massive hole to climb out of. Losses get exponentially harder to recover from the bigger they get. Every G-7 country has seen its market decline by at least 75% at some point. That takes a 300% gain to get back to even. (Let me add here – do you really think you are just going to sit tight the next time this happens if you are using a buy and hold strategy or are you just hoping it doesn’t happen again?)


Everybody thinks they are John Wayne when assessing their risk tolerance on paper yet when drawdowns actually occur I’ve watched even the most self-acclaimed “risk tolerant” over my time in this business make extremely fearful, impatient, and downright irrational (aka stupid) decisions at the worst possible times. It’s why the foundation of any strategy should be protecting the capital before thinking about growing it. With that said the financial industry tends to have so much emotional baggage attached to terms like market timing that their brain tends to hit the off switch anytime someone makes a case for it. Call it what you want, but most of our systems do exactly this – time the market – in an attempt to preserve capital from the massive drawdowns that occur in every asset class at some point in your lifetime. Every asset class is a fantastic investment at certain times, and absolutely horrible at other times.

A quantitative system is NOT designed to avoid the 5% or even 10% normal market corrections that occur just about every year, but instead, the 40%, 50%, or larger declines that tend to occur a few times during every investors lifetime that can absolutely devastate someone both emotionally and financially.
89 replies
Deal Expert
Aug 22, 2011
41802 posts
30056 upvotes
Center of Universe
We'll see what happens.
While I should invest more of my disposable income; having a buffer in the case of a job loss will somewhat mitigate losses in the market!
Member
Sep 9, 2012
372 posts
120 upvotes
TORONTO
Given long enough periods markets tend to fully recover.

I'm young enough such that if markets have a huge decline over the next few years, I won't change my strategy (which is buying index-tracking ETFs).
As I age I'm shifting my portfolio weighting from equities to bonds. If a large decline hits during my retirement years the impact should be less severe compared to a weighting heavier on equities, so again I don't see myself making any changes.

The worse behaviour is to sell low during a decline out of fear and panic... if you don't need the funds in the medium-term, and can wait: do nothing.
If you hold quality, diversified, investments, the less you pay attention the markets the better you'll do.
Sr. Member
Mar 13, 2009
781 posts
212 upvotes
Maple
TorontoDavid wrote: Given long enough periods markets tend to fully recover.

I'm young enough such that if markets have a huge decline over the next few years, I won't change my strategy (which is buying index-tracking ETFs).
As I age I'm shifting my portfolio weighting from equities to bonds. If a large decline hits during my retirement years the impact should be less severe compared to a weighting heavier on equities, so again I don't see myself making any changes.

The worse behaviour is to sell low during a decline out of fear and panic... if you don't need the funds in the medium-term, and can wait: do nothing.
If you hold quality, diversified, investments, the less you pay attention the markets the better you'll do.
Have you ever watched your portfolio losing 50-60%? Do you believe you have the emotional strength to sit and do nothing when it happens? Everyone is very smart when talking about "hypothetical" scenarios, very few can stick to the plan when it actually happens to their portfolios.

But wouldn't you still prefer to prevent this from happening?
Member
Sep 9, 2012
372 posts
120 upvotes
TORONTO
ak1004 wrote: Have you ever watched your portfolio losing 50-60%? Do you believe you have the emotional strength to sit and do nothing when it happens? Everyone is very smart when talking about "hypothetical" scenarios, very few can stick to the plan when it actually happens to their portfolios.

But wouldn't you still prefer to prevent this from happening?
No I haven't, the worst I've seen is it went down~3-4% in a month.
Yes, I believe I have the emotional strength, given my readings/understanding that doing nothing is the right move.

Would I like to prevent it from happening - sure.
Do I think there's a proven reliable way to do so, and one that I can successfully execute over the long-term - no.
Deal Addict
Nov 11, 2006
1685 posts
1196 upvotes
Interesting discussion. In 2008, the Great Recession pummelled my portfolio but thankfully I recovered and have done well since. I added to my positions in 2009.

I watched "Hank: 5 Years from the Brink" for the 4th time the other day to remind myself of the financial pain I went through in 2008; a period I'll never forget especially since I work in the financial industry.

Hopefully I'll have the fortitude to short the market next time a crash happens....and the wisdom to have enough cash to take advantage of course.
Deal Fanatic
User avatar
Dec 14, 2010
7113 posts
9300 upvotes
Speaking as an investor, absolutely. I've been through the 2001 and 2008 crash and I didn't sell anything. Therefore, no losses on my investments. The majority of my holdings went way below its intrinsic value, so that gave me the confidence to sleep at night - no need to sell something for less than it's worth. That's also what gave me the confidence to buy more. Dividends kept growing, and everything bought at that time had an amazing yield. Some companies even had higher earnings during that recession, and yet, prices plummet. That's the proof that markets were emotional. That's also why I don't worry being 100% in equities during retirement - dividend cheques kept coming and I had an increase every year, at a rate higher than inflation.

A solid business with a history of growing earnings constantly, that endured different recessions, is very likely to continue doing so. And a diversified portfolio of strong companies only depends on the performance of these companies - not the market. A diversified portfolio protects against the odd company that might not recover from a crisis as strong as before, like GE (they are much solid now, but it will take years for them to be where they were, largely in part due to risky investments from GE Capital, which is not with GE anymore).

My goal is predicatble growing income, and since I don't plan to harvest the principal, I don't care if the market crashes. There's nothing to sell. It will crash one day, and again and again, and hopefully I have enough cash to keep buying strong companies when they are undervalued. Meanwhile, dividends will keep increasing and compounding.

Speaking as a trader, absolutely. 2 of my 3 automated models have market timing rules, so I'll count on that to detect the new trend and trade accordingly. The other model that doesn't use market timing works like an investing model, buying when undervalued and selling when fairly valued, so I crash wouldn't trigger a sell order.

Rod
Sr. Member
Mar 13, 2009
781 posts
212 upvotes
Maple
Can anyone provide any guarantees that the markets will recover from the next crash, within a reasonable period of time?

Buying strong companies at discount - sure. But there are many examples of stocks that were considered very strong in 2007, but crashed and did not recover till today. Citygroup is one example.

There are a lot of ways to prevent losses. Here is an interesting read - http://stateofthemarkets.com/report/49797/

Traditionally, a diversified portfolio has spread assets across multiple classes. Modern Portfolio Theory (which, by the way, was developed between 1950 and 1970) has split portfolios among U.S. stocks, foreign stocks, bonds, and cash. And then more recently, the concept has been expanded to include additional asset classes such as real estate, gold, commodities, emerging markets, currencies, alternatives, hedge funds, and foreign bonds.

In recent years however, the MPT approach has come under fire as evidence has surfaced that financial returns do not actually follow the prescribed distribution curve and that correlations between asset classes are far from fixed and can vary widely – especially in times of crisis.

Speaking of crises, investors learned (the hard way) that traditional diversification strategies did little to protect them from the two brutal bear markets that occurred in 2000-02 and again in 2008.

The NEW Diversification Approach

Again, we are not talking about diversifying by asset class here. No, the trick to creating an “all weather” type of portfolio that makes hay while the sun shines and seeks shelter when a financial storm hits is to implement what we’ll call the NEW diversification.

When correlations amongst asset classes go to “1” as they have so often during all the crises that have occurred since 2007, traditional diversification is next-to useless as a means to preserve/protect capital.

What is needed is to create “true diversification.” This involves incorporating multiple investment strategies and diversifying across holding time frames, manager methodologies, underlying asset classes, and most importantly, investment managers.

Creating a portfolio that utilizes multiple managers, strategies, and methodologies is likely the future of the investment business. The bottom line is that no single investment manager or firm can consistently “kill it” in all asset classes and all market environments. To think otherwise is sheer folly.
Deal Expert
User avatar
Aug 2, 2010
15196 posts
5016 upvotes
Here 'n There
rodbarc wrote: Speaking as an investor, absolutely. I've been through the 2001 and 2008 crash and I didn't sell anything. Therefore, no losses on my investments. The majority of my holdings went way below its intrinsic value, so that gave me the confidence to sleep at night - no need to sell something for less than it's worth. That's also what gave me the confidence to buy more. Dividends kept growing, and everything bought at that time had an amazing yield. Some companies even had higher earnings during that recession, and yet, prices plummet. That's the proof that markets were emotional. That's also why I don't worry being 100% in equities during retirement - dividend cheques kept coming and I had an increase every year, at a rate higher than inflation.

A solid business with a history of growing earnings constantly, that endured different recessions, is very likely to continue doing so. And a diversified portfolio of strong companies only depends on the performance of these companies - not the market. A diversified portfolio protects against the odd company that might not recover from a crisis as strong as before, like GE (they are much solid now, but it will take years for them to be where they were, largely in part due to risky investments from GE Capital, which is not with GE anymore).

My goal is predicatble growing income, and since I don't plan to harvest the principal, I don't care if the market crashes. There's nothing to sell. It will crash one day, and again and again, and hopefully I have enough cash to keep buying strong companies when they are undervalued. Meanwhile, dividends will keep increasing and compounding.

Speaking as a trader, absolutely. 2 of my 3 automated models have market timing rules, so I'll count on that to detect the new trend and trade accordingly. The other model that doesn't use market timing works like an investing model, buying when undervalued and selling when fairly valued, so I crash wouldn't trigger a sell order.

Rod
Love getting paid dividends while I wait.

Mebane Faber's market timing models work very well (sell when market way overvalued, buy when way undervalued). Problem is they are difficult to actually do.
Deal Expert
User avatar
Aug 2, 2010
15196 posts
5016 upvotes
Here 'n There
ak1004 wrote: Can anyone provide any guarantees that the markets will recover from the next crash, within a reasonable period of time?
LOL, no. What's 'reasonable' anyway.
ak1004 wrote: Buying strong companies at discount - sure. But there are many examples of stocks that were considered very strong in 2007, but crashed and did not recover till today. Citygroup is one example.
So, you wait.
ak1004 wrote: There are a lot of ways to prevent losses. Here is an interesting read - http://stateofthemarkets.com/report/49797/
Yes but people find it tough to do them.
ak1004 wrote: Traditionally, a diversified portfolio has spread assets across multiple classes. Modern Portfolio Theory (which, by the way, was developed between 1950 and 1970) has split portfolios among U.S. stocks, foreign stocks, bonds, and cash. And then more recently, the concept has been expanded to include additional asset classes such as real estate, gold, commodities, emerging markets, currencies, alternatives, hedge funds, and foreign bonds.

In recent years however, the MPT approach has come under fire as evidence has surfaced that financial returns do not actually follow the prescribed distribution curve and that correlations between asset classes are far from fixed and can vary widely – especially in times of crisis.

Speaking of crises, investors learned (the hard way) that traditional diversification strategies did little to protect them from the two brutal bear markets that occurred in 2000-02 and again in 2008.

The NEW Diversification Approach

Again, we are not talking about diversifying by asset class here. No, the trick to creating an “all weather” type of portfolio that makes hay while the sun shines and seeks shelter when a financial storm hits is to implement what we’ll call the NEW diversification.

When correlations amongst asset classes go to “1” as they have so often during all the crises that have occurred since 2007, traditional diversification is next-to useless as a means to preserve/protect capital.

What is needed is to create “true diversification.” This involves incorporating multiple investment strategies and diversifying across holding time frames, manager methodologies, underlying asset classes, and most importantly, investment managers.

Creating a portfolio that utilizes multiple managers, strategies, and methodologies is likely the future of the investment business. The bottom line is that no single investment manager or firm can consistently “kill it” in all asset classes and all market environments. To think otherwise is sheer folly.
Who cares? If you have a long-term time horizon you don't have to worry about any of the issues you mentioned. It's only paranoid investors that need to see their investments increase upward in a straight line that worry about this stuff. It's a fact of life that there is volatility. Accept it.
Sr. Member
Mar 13, 2009
781 posts
212 upvotes
Maple
So you wait? Sure.. Tell it to those who bought Citygroup at $50. It's back to $50 now, but after 10:1 reverse split. That's 90% loss. Their grand grand children maybe will be able to recover the loss.

Citygroup is just one example of stock that was considered strong and safe, with excellent dividend. A 4% dividend really helped those investors who lost 98% of their money. Not to mention that when the stock goes down significantly, the dividend is likely to be cut.
Deal Addict
Sep 6, 2010
2029 posts
804 upvotes
Vancouver
ak1004 wrote: So you wait? Sure.. Tell it to those who bought Citygroup at $50. It's back to $50 now, but after 10:1 reverse split. That's 90% loss. Their grand grand children maybe will be able to recover the loss.

Citygroup is just one example of stock that was considered strong and safe, with excellent dividend. A 4% dividend really helped those investors who lost 98% of their money. Not to mention that when the stock goes down significantly, the dividend is likely to be cut.
If you are going to prove your intelligence when it comes to predicting market direction or waiting for the next once in a lifetime downturn at the very least spell Citigroup properly.
Penalty Box
Aug 11, 2005
4175 posts
1432 upvotes
ak1004 wrote: So you wait? Sure.. Tell it to those who bought Citygroup at $50. It's back to $50 now, but after 10:1 reverse split. That's 90% loss. Their grand grand children maybe will be able to recover the loss.

Citygroup is just one example of stock that was considered strong and safe, with excellent dividend. A 4% dividend really helped those investors who lost 98% of their money. Not to mention that when the stock goes down significantly, the dividend is likely to be cut.
On the contrary, look at how well those that bought citigroup after the split have done!
Sr. Member
Mar 13, 2009
781 posts
212 upvotes
Maple
gwplant wrote: If you are going to prove your intelligence when it comes to predicting market direction or waiting for the next once in a lifetime downturn at the very least spell Citigroup properly.
So this is your proof of my lack of intelligence - the fact that I had a typo in Citigroup? This is very convincing.

Once in a lifetime downturn? The facts tell otherwise - two 50%+ crashes in 8 years (2000 and 2008).

The problem is that after 5 years of one of the strongest bull markets in history, many investors developed a short term memory loss. They think they can continue making 15-20%/year forever. When hard reality hits, most of them are not prepared and see all their gains gone.
Deal Addict
Sep 6, 2010
2029 posts
804 upvotes
Vancouver
Yaaawwwnnnn same old same old another poster that comes out of his/her bunker to predict the end of the world when market grinds higher. You proved my point, in actual fact 2 once in a lifetime downturns, you are looking at the glass half empty when you think these type of events will repeat...but such is the outlook of the doomsdayers.
Deal Addict
Sep 6, 2010
2029 posts
804 upvotes
Vancouver
Further advice if you really believe another catastrophe is around the corner...easy solution, sell everything go to cash hide it under your rock bed in the bunker and poof! You are safe and have weathered the apocalypse! Easy peasy!
Deal Fanatic
User avatar
Dec 14, 2010
7113 posts
9300 upvotes
ak1004 wrote: Can anyone provide any guarantees that the markets will recover from the next crash, within a reasonable period of time?

Buying strong companies at discount - sure. But there are many examples of stocks that were considered very strong in 2007, but crashed and did not recover till today. Citygroup is one example.

There are a lot of ways to prevent losses. Here is an interesting read - http://stateofthemarkets.com/report/49797/

Traditionally, a diversified portfolio has spread assets across multiple classes. Modern Portfolio Theory (which, by the way, was developed between 1950 and 1970) has split portfolios among U.S. stocks, foreign stocks, bonds, and cash. And then more recently, the concept has been expanded to include additional asset classes such as real estate, gold, commodities, emerging markets, currencies, alternatives, hedge funds, and foreign bonds.

In recent years however, the MPT approach has come under fire as evidence has surfaced that financial returns do not actually follow the prescribed distribution curve and that correlations between asset classes are far from fixed and can vary widely – especially in times of crisis.

Speaking of crises, investors learned (the hard way) that traditional diversification strategies did little to protect them from the two brutal bear markets that occurred in 2000-02 and again in 2008.

The NEW Diversification Approach

Again, we are not talking about diversifying by asset class here. No, the trick to creating an “all weather” type of portfolio that makes hay while the sun shines and seeks shelter when a financial storm hits is to implement what we’ll call the NEW diversification.

When correlations amongst asset classes go to “1” as they have so often during all the crises that have occurred since 2007, traditional diversification is next-to useless as a means to preserve/protect capital.

What is needed is to create “true diversification.” This involves incorporating multiple investment strategies and diversifying across holding time frames, manager methodologies, underlying asset classes, and most importantly, investment managers.

Creating a portfolio that utilizes multiple managers, strategies, and methodologies is likely the future of the investment business. The bottom line is that no single investment manager or firm can consistently “kill it” in all asset classes and all market environments. To think otherwise is sheer folly.
Since I'm invested in a diversified portfolio of companies.... History has shown that strong companies always recover, so I firmly believe that fundamentally sound companies will recover. We might have one odd company like Citi (which by the way started declining earnings in 2007 when everybody else was growing) but a diversified portfolio performs like the businesses invested on it. Giants from every sector, that endures every kind of crisis, including war, would have to disapear all at once, for a diversified portfolio be affected.

If it drops.... Great, here's the chance to buy cheap, provided fundamentals are still solid. Citi was a sell in 2010 when every other strong bank recovered and they didn't. Citi fundamentals were flawed. No need to hold it. Move on to the next one. If one's portfolio has 50 companies and Citi is sold at $0, that's a 2% loss of your portfolio. If I had City on my portfolio of 98 companies, that's a 1% loss. The growth of all other solid companies make up for that loss. If one had the index, like the majority do.... Citi wouldn't have made a difference in the long run. Companies will do whatever they can to remain profitable and grow earnings. That's what matters in the end.

Which other strong company that was growing earnings steady until 2007 besides Citi and GE didn't recover? You can count in one hand.

I'm a trader too and I hear what you're saying. But many here are investors, and an approach towards trading won't fly with them. That doesn't mean that they won't have a good total return. For many, managing tradings are more work than one is willing to take.

Succesful investing (and trading) is achieved by managing risk, not avoiding it.

Rod
Deal Fanatic
User avatar
Dec 14, 2010
7113 posts
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ak1004 wrote: So this is your proof of my lack of intelligence - the fact that I had a typo in Citigroup? This is very convincing.

Once in a lifetime downturn? The facts tell otherwise - two 50%+ crashes in 8 years (2000 and 2008).

The problem is that after 5 years of one of the strongest bull markets in history, many investors developed a short term memory loss. They think they can continue making 15-20%/year forever. When hard reality hits, most of them are not prepared and see all their gains gone.
BTW, this is not the strongest bull market in history.

When $SPX crossed 2000 not long ago:

"The chart below provides some perspective to current rally by plotting all major S&P 500 rallies of the last 82 years. With the S&P 500 up 91% since its October 2011 lows (the 2011 correction resulted in a significant 19.4% decline), the current rally is slightly below average in magnitude and above average in duration. In fact, of the 23 rallies plotted on today's chart, the current rally would rank 7th in duration."

http://www.chartoftheday.com/20140903.gif

Rod
Deal Expert
User avatar
Aug 2, 2010
15196 posts
5016 upvotes
Here 'n There
ak1004 wrote: So you wait? Sure.. Tell it to those who bought Citygroup at $50. It's back to $50 now, but after 10:1 reverse split. That's 90% loss. Their grand grand children maybe will be able to recover the loss.
They bought the wrong stock in the first place. Can't win 'em all. My point was more with respect to your entire portfolio not individual stocks that you should jettison if you made the odd mistake. No one is immune from mistakes.
Jr. Member
Sep 18, 2009
103 posts
7 upvotes
Toronto
ak1004 wrote: So this is your proof of my lack of intelligence - the fact that I had a typo in Citigroup? This is very convincing.

Once in a lifetime downturn? The facts tell otherwise - two 50%+ crashes in 8 years (2000 and 2008).

The problem is that after 5 years of one of the strongest bull markets in history, many investors developed a short term memory loss. They think they can continue making 15-20%/year forever. When hard reality hits, most of them are not prepared and see all their gains gone.
Nice thread, this is what I got out of it:
1. Crash cycles are shorter because proliferation of technology and access to trade (so is the market more emotional today than rational?)
2. The truest commodity is time - the young can wait for the market to rebound, the retired can't if tapping into their investments to live.

Can anyone suggest good resources to start learning on how to invest one's TFSA savings account?

Thanks,
A

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