October 2022 Newsletter
In my July Newsletter, I set out a strategy to start buying positions in the least loved sector if and when the S&P 500 falls below 25% year to date (YTD). After a couple of near misses, the market finally crossed over this threshold albeit for a short time. True to my word, I purchased a 3% weighted position in the Vanguard Communications Sector ETF (VOX) on October 13, 2022. The price was $79.89.
A Quick Recap of the Strategy
The strategy is based on an older similar strategy that I successfully implemented during the pandemic bear market of 2020. Effectively, as the market continues to fall, I buy positions at 3 different levels, one at -25% of the S&P 500 YTD, a second at -35%, and a final buy at -45%. The maximum I purchase is capped at 10% of the portfolio just in case things go wrong. The funding for the purchase is borrowed from the margin of the account. In other words, I am taking a loan from my broker for as much as 10% of the value of the portfolio for these additional positions. I am therefore invested at 110% or leveraged at 10% if all three thresholds are met.
The premise of the strategy is that bear markets cycle in and out every 4-5 years. The average drawdown of a bear market is about 35%. Bear markets generally feel horrible to the investor as they slowly make their way down, and near the end, they fall even faster as everyone gets scared out of the stock market. When this happens, the market roars back up with the biggest losing sectors leading the way. This story has played out time and time again. Could this time be different? Maybe, it’s a weird and nutty time for sure, but the odds are that it will be similar to past bear markets. The biggest challenge is that there is no way of knowing how far down the market will go, or how long it will take. Timing these things is extremely difficult. It’s for this reason that I have set up the strategy with 3 tranches so that the more the market falls, the more leverage I use, and the more likely some of the positions are bought near the bottom, before the big move up.
Strategy Risks
I am not going to lie, using leverage is generally a no-no. It’s very dangerous and you should not do as I do. Promise me you will not! You could get hurt! Leverage can make you money much faster, but it works both ways in that you can lose your money just as fast if you’re wrong. In addition to the leverage cap, I have used an ETF to avoid diversification risk. Alternatively, I could have purchased one stock such as Netflix, and risked having it destroyed by Disney in a subscriber war, losing the entire 10%. With the VOX ETF, I have representation of the entire sector and this statistically cannot be entirely destroyed. At the same time I also unfortunately moderate the potential win as I will only get an average return of the sector, rather than hitting it out of the park with that one big winner.
What if the market continues falling past all the strategy thresholds, then does nothing for 10 years? Although possible, from a probability perspective this is very unlikely. The market at the deepest drawdown, say 40+ percent, is very emotional. It’s what’s called a capitulation. This occurs when investors become so scared or distraught, they cash in their stocks and go home to lie in a fetal position. At that point, the market is so oversold that with any positive news, everyone clamors like lemmings to get back into the market, causing a big move up. So I’m making a play on probability and human emotion. No one really knows what the market is going to do. If I did, I would bet everything on the strategy, but I do not. So strategies always have to be a measured bet based on the likeliness of being right. If I am wrong, I could see my portfolio suffer a 1-2% underperformance, which I can likely make up in the future.
As most of you know, I do not like to make big, risky bets. I prefer to beat the market by a little bit over and over – that’s what ultimately wins the game. Swinging really hard to get that big hit means striking out often and possibly losing the game. So strategies need to be relatively conservative.
What If I Am Right?
Being right is the whole point of the strategy, now isn’t it. Being right or lucky (because it’s hard to tell the difference sometimes) will bring me much fame and fortune. If all 3 tranches of the strategy get implemented and the market roars back up to the high, then the strategy could pay out almost 4% of the portfolio over performance. This along with any other overperformance from the rest of the portfolio could make for another big year.
What If I Am Wrong?
Well, this means that I only get a partial strategy in place, which means only the first tranche gets implemented. If the market roars back, then the portfolio will still benefit, but the overperformance will be limited due to the much smaller bet and smaller return. It’s still a win.
Looking Forward
If I am lucky, the market will continue falling and I can implement the last 2 tranches of my strategy. Yes, I do recognize the irony of wanting to see the market fall. The reality is that bear markets tend to create opportunities for people who are willing to buy stock when everyone else is selling. Looking forward, there is an argument for both a continued drop as well as a reversal to the upside. No one really knows for sure. It’s my experience that when the market does get into the bear territory, it usually doesn’t take long to bottom out, whether that is -35% or -55%. So I do expect better days sooner rather than later. Remember, after every bear market in history, there has been a bull market. The better question is how long will it take to get back to previous highs after the bottom? In the last 30 years or so, bear markets have averaged about 14.5 months, but there is a lot of variability and no two bears are the same. Either way, bear markets are normal and I am pretty confident that it will all be good in the long run.
Marc’s Monthly Moves
| Buy | Sell |
| Vanguard Communications ETF (VOX) Genmab (GMAB) | Biogen (BIIB) |
Genmab is a Denmark-based biotechnology company. It specializes in antibody therapeutics to combat cancer as well as other human ailments. I’m replacing Biogen, which shot up 35% this month, with Genmab. GMAB is a much more stable company, it’s international, its earnings growth is good, and it’s more predictable.
Marc’s Portfolio YTD Performance
My portfolio page is LIVE! I will continue to update it monthly. It contains a full list of my positions and the performance information that I’ve included below.
- Portfolio return: -11% (including currency gains)
- Portfolio return: -19% (without currency gains)
- S&P 500 return: -21.26%
- TSX: -11.13%
The portfolio overperformed the S&P 500 by 2.26 percentage points.
Happy investing.
M
Money with Marc 
Another great explanation of your strategy. I can’t remember if it was Buffett or some other famous rich guy who said something to the effect of “when everyone else is selling you buy” or vice versa. That always stuck with me. The problem, of course, is deciding how to classify “everyone”.
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Yes I believe Buffet is credited with the be greedy when everyone is fearful and scared when everyone is greedy or something like that. Its very counter intuitive, and although simple, the timing is also really important. If the market falls 10% quickly and you start buying, well that is great unless the market falls an additional 40%, then you feel like an idiot. They say its impossible to time the market, so at least the strategy tries to catch some of the fall. Even if you are only partly correct, its still a win.
Thanks for your comment.
M
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Hi Marc, always enjoy your comments. One question: how come you have 43 positions in your portfolio. Isn’t 20 usually sufficient for diversification, especially if some are ETFs?
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Michael,
Historically I have almost always held 20 positions give or take. The number 20 is significant as you mention because most of the diversification risk is mitigated. So why 40? Mostly because I was not comfortable with post pandemic economic spending, then inflation, then tightening, then who knows. Its my way of being more cautious, trying to build the most diverse portfolio I can. It adds a little safety , not much, but I certainly wanted to gain some where ever I could. It does come at a cost of being overly complicated and much more time consuming. I will bring it back down to 20-25 when things look more normal…what ever that might look like. But your right, I could have stayed in the 20s and been likely quite fine on the performance side.
Thanks for your comment.
M
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