While history does not always repeat, prudent investors should still be students of it. Something has happened now that should be understood in the right light.
When it happened last, many investors lost about half the value of their portfolio. It was a common joke that 401(k)s had become 201(k)s. Let’s explore the issue with the help of two charts.
Two charts
Please click here for a chart showing the yield curve.
Please click here for an annotated chart of S&P 500 ETF SPY, +1.59%. Even though many investors focus on the Dow Jones Industrial Average DJIA, +1.56%, it is better to use the S&P 500 or Nasdaq 100 ETF QQQ, +2.28%. For the sake of transparency, this is the same chart that was previously published without any changes.
Note the following:
• The white vertical areas in the first chart show recessions.
• During the last recession shown on the first chart, most investors lost about half of the value of their portfolios.
• The first chart shows that the yield curve has fallen to the lowest level since the last recession.
• The first chart shows that the fall in the yield curve has been followed by a recession.
• The second chart shows that The Arora Report gave four signals before the drop in the stock market.
• The four signals include short-selling Nasdaq 100 ETF or buying leveraged inverse Nasdaq 100 ETF SQQQ, -6.82%, which goes up when the market goes down; increasing hedges to protect portfolios; taking profits on select ETF positions in our ZYX Global portfolio; and taking profits on China ETF ASHR, +3.52% in our ZYX Emerging portfolio.
• Please click here for an intraday chart of S&P 500 ETF, which was published when the stock market was staging a strong rally. For the sake of transparency, this is the same chart that was published without any changes. When the stock market was rallying, we wrote: “The chart shows a key reversal. This is positive and, in traditional technical analysis, it means a rally is ahead. The chart shows that the VUD indicator stayed mostly orange during the strong rally from the lows. The VUD indicator is the most sensitive measure of net supply and demand in real time. The indicator staying mostly orange during the strong rally indicates that there was more supply of stocks than the demand for stocks. The market rose because buyers were significantly more aggressive than the sellers. The behavior shown on the first chart of a key reversal accompanied by a negative VUD indicator means that, more likely than not, a subsequent rally may fail.”
• The foregoing call was proven spot on, showing the power of the VUD indicator. The rally has failed as of this writing.
• The last time the yield curve was hitting lows, The Arora Report portfolios were 100% protected with cash and hedges. In addition, we were aggressively short-selling and giving signals to buy inverse ETFs for those who could not short. When most investors lost about half of their portfolio values, The Arora Report subscribers generated significant positive returns.
• This time it is different. Even though we have taken protective measures, they are nowhere near the protection we took the last time. Further, we are only opportunistically short selling and not wholesale short selling.
• Popular tech stocks Apple AAPL, +4.49%, Facebook FB, +2.41%, Amazon AMZN, +2.25% and Microsoft MSFT, +1.87% have been market leaders. Investors ought to carefully watch them. For example, Apple stock rocketed Tuesday after tariffs on phones were delayed.
• Semiconductor stocks have often given advance indications of the stock market. Popular semiconductor stocks AMD AMD, +0.05%, Micron Technology MU, +4.71%, Intel INTC, +2.97% and Nvidia NVDA, +3.20% are worth watching.
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What’s different this time
Here are the big differences this time compared to last time.
• There are negative interest rates around the world.
• Negative interest rates cushion any potential drop in the stock market.
• Central banks have more tools, such as quantitative easing (QE).
• Politicians are more prepared on the fiscal front.
• If the trade war gets resolved, it may trigger renewed global growth and higher stock prices.
• Mortgage standards are much stricter.
• Corporate and sovereign debt is a bigger danger.
What to do now
Investors ought to consider following a proven model. It is important that any model that investors follow is not a static model. Since the market, economic and geopolitical conditions have dramatically changed, the models that worked in the past may not work this time.
Investors ought to consider adaptive models that automatically change with market conditions. The difficulty investors face is that there is a scarcity of such models that are proven in bear markets as well as bull markets. An example of a proven model in both bull and bear markets. Right now the ZYX Asset Allocation Model has taken some protective measures but its overall stance is still to hold good long-term positions.
In an environment like this, investors interested in higher returns with lower risks ought to consider following Arora’s 18th Law of Investing and Trading: “Diversifying by time frames provides a consistent stream of profits.” When I started writing this article, the Dow Jones Industrial Average was down over 100 points. Then the news came that some tariffs will be postponed. The market jumped about 600 points from the lows. Investors can take advantage of such volatility by diversifying by time frames.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.