Market Volatility


Market Volatility

Key Concepts from our live seminar

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Quiver's Guide to Market Volatility - Today's Contents

Market Cycles- All markets go through cycles- this is the ups and the downs of the market. We will discuss what the market has done in the last ten years, where we currently are in the cycles, and where we may be headed in the next couple of years.

Technical Ways to Manage Risk- There are a few tools that professionals like myself use to determine how we may manage risk. We will dive deeper into a few of the more popular tools used for market analysis, and how they may help to mitigate risks in the market.

Noise vs Substance- There is a lot of noise in the markets: such as headline items, media back and forth, and this can cause markets to fluctuate short-term. Then, there are things of substance that are structural and can change the markets over a longer period of time. We are more concerned about substance, as a majority of our clients are investing with a three, five, ten year timeline in mind. 

Where we may be within the current cycles and how to allocate- Using the tools that I am about to share with you, we will discuss where we may be currently, and how we may find value in certain investments in the current market.


The Denial-Panic Continuum - The Emotional Cycles of Investing

Denial - Panic Continuum - the emotions of investing

We show this chart at basically every event we hold. It's an important graph, because it makes logical sense. 

Every asset goes through this continuum. It doesn't matter if it's an individual stock, the bond market, the real estate market, whatever it may be. Everything goes through this cycle and this cycle can happen in a variance of timeframes. Sometimes it happens in a week, in a month, in a year- you can basically break it over periods of time but for the big picture everybody starts off with optimism

Why else would you take your hard-earned money and put it into an investment?

The only reason you would do it is you're hoping it makes you some money. Now, the funny part is that as that progresses, if you're lucky enough to pick the right horse, and as it starts to come around the corner, you start to see your account values increase. If it's happening enough, your emotions do change. You start to feel more than just optimistic, you start to see your account balances and your net worth get to a point where you really feel pretty darn confident and euphoric. Right up here is when most people start to add on risk or take on additional risk. 

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Do you know why?

Right, you feel good. You take more risks when you think you have more than you need. You're willing to share, you're willing to take additional little risks because if you do take a loss it's not as painful, as you're starting from a higher point.

That's usually the worst time to take a risk. The way these markets work is that once you reach that level you'll go through the downside, what we call the washout or the correction. People start to feel the pain of loss. Everybody has a point of capitulation where they say, "Listen, this isn't working, I can't handle this, I need to get out.”

Now, remember the old saying, the trick to investing is buy, low sell high. It's very counterintuitive because if prices are low, what do you think the news is like?

The news is usually bad at low prices!

That's why it's so hard to buy: nobody wanted to buy Ford at $2 when GM went bankrupt a week before. This was the best time to buy! 

It didn't make sense at the time because there was so many scary things going on in the news that it made it hard for many people to pull the trigger. 

My goal as an advisor is to avoid these large downslopes. The studies say that most investors spend 80 percent of their time in recovery mode because they decided to take risk when they felt good, when the news was telling them everything was good, the market was all-time highs, and every day there was a new record being broken. It makes sense that you want to get involved because you might be missing out. 

As an advisor, my logic is, rather than get people in near the top of a cycle, we try to help them figure out what assets are in that bottom part of the cycle. We try to teach people how to take their money and get into the purchasing process when you're at that hope and relief and optimism part of the continuum rather than the euphoria part. 
 


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The last year and a half we had what we call a “melt up.”

It was an “outlier market,” meaning that it was just pushing higher, and higher every day. As the market kept moving higher, and it started to feel like it could never go down.

A kind of greed and delusion start to appear, and you get a lot of people say, “Oh this is a new paradigm you know the markets are different now, and we should have higher valuations because of this reason or that reason.”

I've been doing this 22 years in 1999 everybody thought it was a new paradigm because of the dot-com era.  As  we know now, in 2001 - 2002 that new paradigm got its face ripped off.

So typically when markets start to change their tenure, you get that first decline like we saw in February, you get a balance like we saw in March.

We call that the bull trap. You know why people say patience is a virtue? Because most people don't have any patience! And investors are no different. 

On that first dip everybody is so eager to get in that you do end up getting a bounce back, but then when you roll over and break that lower level that's when you start to get into that cascading effect, where markets tumble lower.

I think we just got done with a little bit of a bounce- that kind of would suck the buyers in. I believe it's the next one that people should be buyers at.

So, how do we determine where we are in these cycles?

What are some of the tools that we use that help us figure out where we are along the road?

There are a lot of different market analysis in what we call cycle analysis- I'm only going to share one.


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Elliott Wave is something that's been around for a very, very long time that named after the originator of it.

Elliott started to see that there were repeatable patterns in markets, and as he dug deeper he started to realize that markets work like fractals.

Fractals are basically a pattern that is repeated time and time again in different time frames.

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This chart that shows “1 2 3 4 5”- think of that as a very long period of time. That "1 to 5"- Maybe that's 7 to 10 years in time. This first climbed the "one" is the first fractal- if you looked closer, like under a microscope, it's broken up into five waves that complete that one, and then same thing if you took the time frame and shrunk it down again. The same pattern is repeated but in a more minut way. You can keep repeating this time and time again, all the way down to the minutes within a market.

Some people see this as voodoo, or something of that nature.  However, when you start to study the markets, you see that this gets repeated time and time again.

This tool can help us figure out where we start to put our entry levels or exit points and helps us manage certain parts of the account.


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Fibonacci and the Golden Ratio

Fibonacci was an Italian scholar.  He came up with what's called the golden ratio. 

This is a special ratio which can be used to define the proportions of everything in our universe- from the smallest elements, such as atoms, to the largest and most advanced patterns in the universe, such as the galaxies.

This innate proportion appears all throughout nature, and the financial markets also seem to conform to this "golden ratio" as well.

In investing, some advisors that use technical analysis use the golden ratio to indicate support of a price level, or resistance to price increases, of a stock or commodity. 

After significant price changes, up or down, new support and resistance levels are supposedly found at or near prices related to the starting price via the golden ratio


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Can you separate the noise from the substance?

Noise will cause a market to go up or down in the short term- it'll cause a reaction that lasts from a day or two, to a week.  Something of substance causes a change in the market for years, or influences the market over a longer period of time.

Tax Plan- The new tax caused a "noise" reaction when it was first released, although depending on how solid the plan is, it can also be quite substantial. A lot of the key elements of the tax plan have expiration dates, so that is something to keep in mind. The effects may eventually wear off.

Trade Tariffs- Noise. What I found when I researched this, is that in most cases in the process like we are right now you get some short-term reaction. So, for instance, yesterday when I woke up in the morning and the market was down 450 points the headline was China was going to react on the trade tariffs, but the market ended the day up 250 points. Also, trade tariffs are transparent, in the sense that the information is all out there, we know what we are going to have to deal with, and Wall Street will adjust their portfolios accordingly.

North Korea- Noise. The threat of nuclear war is real, sure, if one of these crazies does push a button, and sends a missile that could become substantive. But as of now, the back and forth jabbering from an attention-seeking dictator is likely just noise.

Stormy Daniels- I threw that one in for humor- definitely noise.

Russia Investigation- Noise. This is like Obama's birth certificate, and Bill Clinton's Monica Lewinsky.  Every politician has some thing that the other party chases them on. These are distractions that keep getting replayed in the news, but in the end it is just part of the political game- The markets don't care. 

Changes at the Federal Reserve- Janet Yellen just left, and now we have the new guy, Jerome Powell.  Also, there have been a certain number of chairmen vacant for quite some time, giving Trump the opportunity to appoint two to three new Fed chairman. This is pretty unique, as this is the first president since the Federal Reserve was created that will have this much of an impact on the this system. I would call this substantive.

Interest Rates-  I think interest rates are a little more substantive because they do affect the flow of capital within markets. Below is a chart that backs up this statement.


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This is a chart of the S&P 500 from 2009 to 2016

The colored areas are the times that the central banks provided more liquidity. Before, when markets would slow down, the central banks lowered interest rates. Once interest rates are lowered to about 1%, you can't go much lower. What do they do next? They turn on the printing press. The government starts to buy into the market, providing liquidity, and pushing the market higher.

In the lower part of the chart, it was only the US pushing the cart. ECB and Bank of Japan have now also begun providing liquidity in the markets up here, in the green circle.

Now, the Bank of Japan are going to be reducing the number of bonds they buy. The Federal Reserve has announced this as well, and we will likely see the EU do the same.

At this point, the markets are going to have to fend for themselves, and play like they used to in the old days. Without liquidity being provided to a market, you can't push a market higher. For the first time in 8 or 9 years we are seeing a big change in the liquidity in the markets. This is something I think people will need to watch.


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This is a chart of the S&P 500 from 97 until now.

For a while now I have been saying to people, you don't have to have a recession to have a big decline in the markets.

In these columns, 98, 99, 00, these numbers (4.5%, 4.5% 4.7%) represent the GDP growth in the US. After the year 2000, we had a significant drop in GDP growth, but we didn't go negative for a whole fiscal year, we still printed a small gain.

However, in that time frame, the S&P 500 was down a whopping 46%.

There was a change in the way earnings were happening, there was a slow down. The market got too far ahead of itself, a lot of capital was coming in with the excitement of the internet, and technology. 

What is really interesting, when you get bear markets like this, you also get some of the biggest rallies.

If you look at the areas circled in green, we had an 18% and 23% rally. This is where it gets very difficult, because some investors buy in at the wrong time, thinking they may miss out on opportunity because they just saw a short term rally. That is where our tools such as Elliot wave and Fibonacci numbers come in handy.

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This is the same time frame, but a different market. This is the Nasdaq, which holds technology and internet based investments.

Like I said, I was new in the business around this time, and thankfully had good guidance. It was around this time that my two mentors, both 15 years my senior, came to me and said, "Colby, we have never seen so much money be made in the markets like right now. We are going to tell our clients to move half of what they have into the money market."  I thought, ok, you guys are smarter than me, I will make the same recommendation to my clients.

The idea is that if you move half of your money to the sidelines, you still see some growth, but you also have a parachute if things start to fall. As I have seen time and time again in this industry, markets have certain patterns, and if you have use techniques like this to mitigate risk, you will have more capital on the sidelines to put to work once the correction has come to an end.


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This is where we think we are in the process of things. I like to start with a long-term view point. 

If you can invest with the trend, that works a lot better than trying to work against it. So I look at the long term view point, and the trend is upward. In order to violate this trend, you need to get a pretty deep correction. 

If you connect all the tops, and all the bottoms, you create what we call a "channel". Until you start trading outside of this channel for a matter of days to create what we call a clean break, the trend usually continues. 

With this basic thesis, I start to look for evidence that can back that up. When you bring Elliot waves into this analysis, when we get to the 5th wave, we start to look to take money out of the markets, and reduce risk, as it may indicate a larger bear market.

There is a difference between a top in the market, and "the" top. A top is short term, "the top" will do material damage to your net work if you time it improperly.

The wave patterns help us determine if it is a shorter or bigger time-frame.


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This is the five waves on a shorter time frame. We just finished the third wave, and according to our analysis we are in the 4th wave, and we may have an additional year or two of growth in this market. 

There are a few rules in Elliot Wave.

The third wave should be the longest and strongest of the pattern, and 4th waves when they correct should stretch out over time. 4th wave corrections create maximum frustration, and that is what fuels the next leg higher.

That is where I believe we are headed.


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The traditional way of asset allocation, or diversification, that I was taught when I came into the business was just like this: You split your account between stocks and bonds, equities and fixed income, because typically as the markets go down, fixed income goes up or stays even.  It creates a balance.

Some people use the Rule of 100- You would take your age, and subtract it from 100, let's say you're 70 and they would say, ok 30% of your money should be in equities ,and 70 in fixed income. While that is a cute little standard, I have many clients that need the income their portfolio produces, and another part of clients that doesn't need this income for themselves, and are willing to take more risk.

You really have to break it down for each individuals unique situation.

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The next thing that happens, is they say "let's diversify that."

They start filling their portfolio with 10-20 different mutual funds, and say, "I'm diversified." You look diversified.

However, if 70% of the portfolio is correlated, than you really aren't diversified at all. Because our client base doesn't have 10 years to recover, we have come up with a different model.

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Instead, we take that model and put it in the center of our core strategy. We buy things that fundamentally make sense, good strong stocks, in an account with the lowest fees. This is the buy and hold section of the account.

The strategy then is to adjust the risk based on where we are in the market cycles, by bringing these assets to cash when the cycle starts going down. We bring in tactical managers that are certain percentages of the portfolio to help balance the longer term goals with what may be happening short term in the market.

If we are in cash when the market does see the fifth wave, and has a substantial decline, that is where we will be able to buy back into the market, the good strong names like Ford, Pfizer, with our capital that is sitting on the sidelines.


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A corporate bond is just you loaning money to a large corporation, and they pay you an interest rate until they pay you back.

When a bond is issued, they are issued at a par value of 100, and mature usually at 100.

In between issuance and maturity, they are in a market, and the price of the bond can go up or down. It is a "discount" when it is below 100, and a "premium" anytime it is above 100.

In 2015 the Chinese markets were taking it on the chin. YUM brands was being affected some by what was going on during this time.  But when you buy a bond, the analysis is on the company. Will the company still be in business when your bond is set to mature?

At this time, we were able to buy some of these bonds between 88 to 90.  A buyer at 90 that holds to maturity at 100, they have a built in capital gain, plus the income. It's not that bad of a return, and you don't have to worry about the market as much. As we start to look to take less risk in the stock market, corporate bonds are some of the opportunities for us to be able to buy some decent quality names at discounts.


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