No. of Recommendations: 8
All well and good, but where does the money for that big buying come from?
Indeed, Clements does not answer this. He first writes that he doesn't lighten up on stocks:
Indeed, As I’ve argued before, I’m not inclined to lighten up on stocks when the market appears overheated, because there’s no limit to how high share prices might climb.
And then he goes straight on to say when he buys:
That’s why I invest more in the broad market whenever there’s a steep drop. No, I don’t try to figure out whether stocks are objectively cheap, because I’ve learned market yardsticks can’t tell us where the market is headed next. Instead, I simply take my cues from the magnitude of the market’s decline, and the bigger it is, the more enthusiastic I am about buying. That might sound naïve. But after decades of investing, buying aggressively during a bear market—coupled with leaning heavily toward stocks and favoring index funds—are the only ways I know to get an edge.
Interesting 'edge' given that it is logically impossible to implement. He mentions bonds at 40% in the comments, but holding bonds at that rate exceedingly unperformed a 100% stock allocation. Changing the allocation to more stocks after steep declines would outperform the 40% fixed bond strategy (but not outperform a 100% stock strategy except he also wrote he doesn't lighten up when he thinks the market is overvalued.
Regarding the overall sentiment, though - buying index funds after steep market declines - you might consider taking the opposite trade. After steep market declines (say over 40%) in the S&P500, the businesses considered viewed as junk can decline far more than the S&P500.
If you want an edge over the S&P500 whilst largely invested in the S&P500, and you don't like to pick individual stocks, and you want to remain fully invested - then here's one solution: Whilst remaining fully invested, you could hold an index fund for the majority of the time, but then move all of your equity into a bucket of at least 20 low quality firms that no-one wants during market declines. You are taking the opposite trade of people searching for quality whilst experiencing fear, which puts a premium on large cap stocks and those with the strongest economic moats.
When the S&P500 recovers, the 'junk' stocks also recover, but from far deeper lows, so you can experience enormous gains. When the market recovers, switch back to the index fund.
This can be backtested if we define a "steep market decline" (when moving into junk) as a decline of 50%, and "recovered market" (moving back to the index) as the S&P500 reaching its former high. The junk could be defined stocks that have fallen at least 75% from their former high, and from that group taking the top 20 as ranked by the highest 5-year past return.
I wouldn't have the nerve to follow such a strategy, I have to admit, but if you were a pure numbers person I believe it would have outperformed a fixed 100% S&P500 strategy over the last 30 years by quite a margin.
- Manlobbi
