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How the Market Works

Making Money in a Flat Market: How the Market Works

Posted by kdadmin on April 30th, 2016.

Making Money in a Flat Market:  How the Market Works

And just like that, all of the stock market’s gains (SPY) in April were erased.

Good thing we didn’t own any stocks. But we did buy something new …

The First Step in Making Money is Not Losing Money

Warren Buffet famously said that his two rules of investing were:

  1. Never lose money.
  2. Never forget rule #1.

While funny, it’s a great point. FAR too many investors rationalize a poor exit strategy with the phrase, “but I’m in it for the long haul.” THIS IS JUST STUPID.

Think of it this way. If you’re standing on the railroad tracks, and a freight train is barreling down on you, why on earth would you keep standing on the tracks? Why wouldn’t you simply step off the tracks, let the train pass, and then step back on the tracks?

As I explained in my last article, This is NOT a Bull Market: How the Market Works, we are not in a bull market. In fact, the market peaked last May, and try as it might, it has not been able to achieve those highs since. Instead, it has sent us through a couple of huge volatility swings.

What does this tell you? What have I told you? There is very little upside for stock, and a HUGE risk of a large downside. In other words, the freight train is coming. I’m not on the tracks. Are you?

Making Money in a Flat Market

If you look at the chart above, you’ll notice that the stock market (SPY) had a volatile month. If Shakespeare’s Macbeth had been an analyst, he would have said, “Out, out, brief candle! Told by an idiot, full of sound and fury, signifying nothing.”

But, as you know, we’re not invested in the stock market. We’re invested in the bond market, here illustrated by AGG, the aggregate bond ETF.

Now, look at the chart below. Last week, given a peaking stock market and a likely slow Fed interest rate hike, we added to our bond position with a long term bond play. For the sake of example, I’ll use VGLT, Vanguard’s long term bond ETF. Notice what happened to long term bond returns when, midweek, the Fed decided not to raise rates (bonds went up). Notice what happened to the stock market returns (they went down).

Since it is extremely likely that the Fed will continue to raise interest rates over time, we are going to be invested in long term bonds and aggregate bonds, but not stocks.

SPY AGG VGLT chart

The Proof is in the Pudding

If you’ve been following my series on How the Market Works, you’ll know that we’ve been out of stocks, almost entirely, since May of 2015. Sure, we dabbled in late January / early February to make a nice profit on that market down spike, but as a long term play, we are not bullish on stocks.

So, how have we done? Have a look below. This chart covers the last six months, since the Fed rate shift has taken place. Now, tell me:

  1. In which of these two investments would you prefer to have had your life savings?
  2. Which one would you prefer to base your retirement income upon?

SPY vs AGG Six Months to April 30 2016

If you’re like me, you’d prefer a bird in the hand (bonds income) to two birds in the bush (stock market returns). Especially now, when we’re near the all time high of a stock market driven by a now unraveling, unprecedented, federal financial stimulus.

As I’ve said before, it’s likely we’ll see more stock market volatility this year, as the market works its way through its bipolar grief cycle of no more Federal Reserve stimulus.

It’s gonna be fun …

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