S&P 500 Looks Healthier Than It Is. How To Diagnose It.

Once again, a few stocks lead the many. This is a time for pre-retirees to understand what that means.

This is probably a good time to remind you that I am neither a bull nor a bear. I am a realist. So, while some professional investors manage money with an emphasis on “where’s the market going,” I favor a different approach.

I cut the market into many smaller pieces, and make decisions based on more of a “weight of the evidence” approach. That is, I don’t stop my market analysis after checking out the S&P 500, Dow and Nasdaq NDAQ . I dive deeper, and analyze fundamental, price and sentiment patterns of those smaller pieces. History is a key guide here, too.

Focus now, so you can relax later (when you retire)

I mention this because I truly believe we are at the most pivotal time in the lives of the generation of investors I belong to: the Baby Boomers (I just made it, born in 1964). You see, markets are cyclical.

And while anything can (and will) happen in the global financial system, that is out of our control. So, we should stop trying to control it. Or even worse, think we can control it.

What IS within our control is how we position our wealth to give us the highest likelihood of retiring the way we want. To do this, it is essential to understand how those stock market “headlines” get created, how they evolve, where the hidden risks are, and how to translate that into investment portfolio decisions. You either do this yourself, offload it to someone else, or do what too many Boomers are doing: leave it to chance.

This is why I rail against “60/40” portfolios, and strategies that rely too heavily on the stock market producing 10-15% annual returns. The odds of that happening over the next decade or two is remote, in part because what we just saw last decade happens so rarely. But the “recency” effect is a strange, and dangerous thing.

Current conditions

As this chart shows, the S&P 500 is doing it to us again. It is masking (pardon the Covid reference) the underlying health of the broad stock market. I will cover stock valuation in other articles. Here, I am simply pointing to how the “market” rally since March has been as deceiving as much of the rally that took place in the few years leading up to the 2020 S&P 500 implosion. If nothing else, that should give us pause.

I track a watchlist of ETFs that help visualize the market’s “internal” health. So, when I heard on TV this morning that the S&P 500 was flat since March 6 of this year, I instinctively took a look to see if some of my own indicators matched up. Here is what that chart tells me.

The S&P 500 (SPY – the blue line) did dive and recover. It is up very slightly since March 6. Nice job, S&P 500!

Symbol FDN (the orange line), which tracks a group of stocks that are modern-economy leaders, but do not pay dividends, is up 18% over this same time period. Several of the largest positions in FDN are large positions in the S&P 500. They have lifted the S&P 500 much higher than the rest of the stocks have.

Stocks that pay above-average dividends are nowhere near the “comeback” implied by the S&P 500’s flatness over the last 2 1/2 months. I chose 3 ETFs (SDY, SPHD, SPYD) which each pay higher dividend yields than the S&P 500, AND whose holdings are all within the S&P 500 Index.

Same script, different year

That tells me that recent market activity is just another version of the same old story: low-yield and zer0-yield stocks continue to be out of favor with investors. Those 3 ETFs are down about 9%, 15% and 18% at the same time the “headline” S&P 500 is slightly positive. This is a microcosm of the last several years. In other words, after the 5-week selloff that took 1/3 of the S&P 500’s value as of February 19 and made it vanish, most of the stock market is still in critical condition.

To me, that means the whole market is in critical condition. In the long-term, your portfolio strategy is only as good as its weakest link. History is littered with “narrow” stock markets that ended with a generation of disappointed investors. Or, as one old definition I heard goes: the definition of an investor is a disappointed speculator.

The way forward

I have made a few intermediate-term guidelines for the portfolios I manage. First, I will not resume purchasing any individual stocks until I feel there is a low probability that the stock will drop more than 10% from where I purchase it at any point during the time I hold it.

I aim to hold most of the stocks I buy for more than a year. So, in an environment where there is likely some unfinished business to the downside, that list of potential stock holdings is pretty thin right now.

Hedged Investing for Boomers

Next, I think that this may be the best time in the lives of Baby Boomer investors and retirees to learn the basics and benefits of what I call “Hedged Investing.” Specifically, one aspect of that is to look for profits not through “stock-picking” right now. Instead, identify “pairs” of securities (typically ETFs), one that you think can outperform the other.

This can be done in a variety of ways, but the one I favor in this environment is to hold one or more ETFs I think will perform relatively well, and pad that investment with an inverse ETF that “shorts” some segment of the broad market. I described this in a Forbes.com article recently, so take a look there, or just ask me about it.

The goal is to try to profit in tenuous times, but in a way that keeps your range of possible outcomes fairly low. I think it’s a lot better than this “in or out” approach so many investors run to at times like this. After all, when the market headlines tempt you to only see the tip of the iceberg, you need to find a way to steer the boat around it.

Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors.

Source: Forbes – Money