“Every strike brings me closer to the next home run.” – Babe Ruth
Last September we penned The Babe Ruth Effect to explain what one might expect from a trend following model like MarketVANE. As we pointed out, roughly two-thirds of “the Babe’s” at bats resulted in outs, meaning that every time he stepped up to the plate the most logical expectation would be that he would fail. That said, when Ruth did connect with the ball he tended to be very, very productive. Over the course of his career he averaged 7 bases gained for every 10 at bats, more than any other major league player in history.
Similarly, MarketVANE could be described as having a relatively low “batting average” but a high “slugging percentage”. Most of the cash signals it gives us end up being wrong, but when it is right it will tend to be right in a very big way.
In mid-December MarketVANE STOCKS went to 100% cash and remained there through the end of last month at which point we re-entered the market. The chart below shows how this trade worked out for our clients. The green line obviously shows a return of 0% for our cash position while the black line depicts the MSCI All-Country World Stock Index, our benchmark for the stocks asset class.
As you can see, shortly after we went to cash the benchmark began dropping precipitously and declined by as much as 10% through mid-February. However, things quickly changed course and stocks rebounded sharply over the following six weeks, finally triggering a buy signal for us to re-enter the market.
Going back to our Babe Ruth analogy, we would consider this cash signal to be a “strike”. Overall it cost us a little over 1% in relative performance. But as the Great Bambino said in our opening quote, “Every strike brings me closer to the next homerun.” We echoed this sentiment in our September blog post when we said,
Most head fake signals reverse themselves quickly and result in relatively small amounts of underperformance vs the benchmark, while the occasional home run signal can produce more than enough outperformance to make up for all the head fakes.
So did MarketVANE do its job with this last cash signal? We would answer that question with a resounding yes! It correctly reacted to a breakdown in price momentum, sidestepped a relatively volatile patch early in the year and corrected itself by getting back in line with the market once an uptrend resumed. Sacrificing small amounts of relative performance vs the benchmark is a perfectly reasonable price to pay for the sake of having a risk management discipline in place that is likely to help us preserve capital in the next market crash. We don’t expect to connect with the ball every time we swing by the bat, but we do believe we have a process in place that will produce great results over the course of our collective investing careers.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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