Tom Discusses How His Investment Strategies Address Changes in Markets
Transcript:
Katie Nealis:
In the past, we’ve talked, we’ve talked about the bull versus the bear market before. And just straight off the bat, we have a pretty amazing question in from one of our clients asking, since we are at the last stage of the bull market, we are anticipating the end of the bull market at the beginning of a bear market in a couple years from now, what would you do to prepare for the bear market? And how would you invest our money in this situation in a transition from the bull to bear market?
Tom Vaughan:
Yeah, that’s a really good question, actually. And there’s a whole bunch of layers in there that I’ll try to cover. But the first one, and I think probably the most important thing to look at there, you know, he, he’s asking about preparing for a bull market. And so one of the things that you have to think about in terms of preparation for a bull market, is just how much stock versus bond that you have in your portfolio. So like the total risk of the portfolio, which is super important. And we have some data going way back to 1926, that’s provided by Vanguard, that kind of shows for each level, you know, 10%, stock and 20% stock, you know, historically, what was the worst one year period. And so it kind of gives you an idea for what you’re getting involved with in terms of that total risk. So that, that’s, that’s one of the ways that we prepare for a downturn of any type, even the smaller ones. And so that’s how you kind of can moderate some of the risk in the portfolio. But beyond that, I mean, truly preparing for a downturn is what I call predictive. And so and what I do is what’s called reactive so and that’s it, there’s a big difference there.
I don’t believe you can predict the next bull market, I believe that they will happen, but I don’t know when they will happen. There could be one that starts on Monday, or could be 15 years from now. And so that that’s the hard part to really tell is like when when it’s going to happen. So I tend to get the clients into this mixture of stock versus bond, you know, maybe it’s 100% stock, maybe it’s 60%, stock and 40 bond or whatever the mixture is. And once we get that we basically manage the portfolio as if the markets going to continue up. And then we try to react to those downturns, let me share my screen and I can show you some different pieces here that I think are going to be useful. So this is the s&p 500 for the last 25 years. And so each one of these little dashed bars here is a month. And so you can see, you know, we had our 2000 downturn, right, we had our 2008 downturn, and we had our, you know, just this pandemic downturn, it just happened last year, this was about 40%, about 60%. And here’s 35%. This is actually the fastest 35% downturn in history. But one of the things you have to pay attention to here is that month by month, if you look at this, there are more up months here than there are down months and there’s more upturn altogether, there’s only three big downturns that have happened in this 25 year period. And so you have to kind of assume that the markets going up because the probability is that the market is going up. And so that’s kind of one of the first things that we always think about, is trying to stay invested as much as possible. But then you want to put in some protections over a period of time to try to figure out you know, what you might do if things do start to go down.
And so some people will just buy and hold, and I have clients that want to do that. And we’re fine with that. Also, you just got to make sure that you understand what that means as far as that goes. But I’ll show you what we did in this particular downturn here that just happened in the pandemic. So the first thing that we do is we use the stop losses. So let me pull up a different chart here. So here’s Apple for the last 12 months. And so again, every one of these little boxes is a day, right, and this is the 200 day moving average. And this is a very important portion of this chart, this is what’s called the volume profile. So this shows, each one of these bars shows how much volume or how many shares essentially were transacted at that particular price. And so you can really see, you know, where things were purchased. This red line shows the highest volume of purchase for the time period for the for the year. So the first thing I’m going to do here is I’m going to start to put in alerts, and I’ll just show you how I do this. So one of the things that is very, you know, common within the trading community is this 200 day moving average. And oftentimes when a stock falls to the 200, day moving average, sometimes it’ll accelerate down from there. So I’m going to put our alert, you know, really right here, right under this 200 day moving average. I’m not going to respond to that, especially for a company like apple, but I do want to know that that happens. So there there’s an alert.
I’m going to put a second alert right here at the you know, highest level of volume. And what I’m what I’m trying to do here is you know, really identify these areas of high support. So what happened is if you look throughout this year, more shares are transacted at this price than any other price. And so often when when the market comes down and gets to that level, you’ll see a bounce. But if it happens to crack through that level, then we’ve just broken that support. And if you look down here, and this is where I would put my stop loss, if I had had, or at least an alert, I use both alerts or stop losses, depends on what I’m trying to do here. And so here you see, there’s basically no volume underneath. So if it gets through here, it could fall all the way down. And that’s a fairly big significant motion. So that’s the reactive portion, I’m getting notified when things are happening. And then eventually, when it gets down bad enough, I might reduce my position or eliminate that position. And so we did this this year, when we had the huge run up early in the year and all the clean energy and what have you, we put stop losses in place. And it worked out really, really well.
So that’s the first piece and then let’s say that something triggers, you know, then what do we do with that money? Well, the first thing I do is I look for me pull this chart, oops, sorry, I look for positions in the market that are doing better than the market itself. So this purple line right here is the vanguard total stock market index is the ticker symbols VTi. I love using this because it’s essentially every stock in the stock market. And then this line here, right now is Apple, okay, so you can see that Apple fell a lot less during the downturn, because this is from the very top on the ninth of February of last year, to the very bottom here, which is the 23rd of March. And so it fell a lot less, and then it actually ended up kind of continuing its movement upward. So it was down 10.6% instead of 17. So I like to rotate those pieces that we’ve freed up with the stock losses into holdings that have fallen less than the market. And the other piece of this, that’s super critical. It’s not just trying to protect how much you, you know, lose.
On the downside, it’s actually more important on how fast you bounce back. So I’ll give you an example. Let’s say you have a portfolio two options, one, where the portfolio would drop 30%, but you’d make your money back in three months. And another one where it only drops 3%. But you’d make your money back in three years, I would personally take the negative 30. Because it comes back that quickly. So there isn’t just it isn’t just how much it falls, it’s how fast it comes back. And one of the things that I’ve seen is if you, if you use the data that’s coming to you, when the market is falling, and you start to rotate into those things that are falling less, oftentimes, they bounce faster, and come back faster. So I got some other examples. And we bought Apple on the fifth of March, we also bought Microsoft at the on the fifth of March. And you can see great bounce down 6.8% instead of 17. We also purchased health care, you know, again, huge bounce down 5.6%, basically, instead of 17. And these are things that I saw falling less than the market. And we rotated into those. We also bought cybersecurity because everybody was going home. And that was you know, and that’s down 7.5%. So 17. And we bought genomics, this is a DNA. And that was actually up in that such huge bounce, right? This, this actually included Madonna in it, which obviously became you know, something everybody got to know pretty quickly. And so that that’s that’s the second part of the strategy is just that ability to, you know, get into something that is falling less. And the hope that that bounce is the higher and faster, we can recover quickly.
Now, I didn’t buy these, you know, up here at the bottom in this down timeframe here, just because I could see that they were falling less than the market. And that’s what I’m looking for in downturns I start scouring through, because what I’m seeing is that the market is saying, Hey, we still like these things more than the market as a whole. And like for Apple and Microsoft and I have huge cash positions, you know, for this particular one here with this genomics piece, obviously, you know, they have some need for a new vaccine. And so that, you know, the market is automatically telling you, you know what they’re still interested in. And so that’s a really big deal. And we did this, these are actual trades that we did during this downturn. And the other thing that we did with some of these pieces that came out of the stop losses and what have you was to move into long term treasuries. So if you look at this, this is a it’s called a dv, right? It is a Vanguard extended duration Treasury. during times of stress, people fly to treasuries because they’re safer. And then usually there’s an interest rate decreased by the Federal Reserve in these big downturns and so that also helps the price and you can see that this was actually up 19.8%, you know, in the same timeframe when the market was down 17. So we will put five to 10% of the portfolio into something like this into these kind of long term treasuries. So even if we have 100% stock portfolio, we might go down to 90%, stock and 10%, long term treasuries and those types of things. And so this was a strategy that we use very successfully actually, then kind of the last piece here really is the ability to use an inverse position. And so an inverse, this is pro shares. And this goes in the exact opposite direction, the s&p 500. So if you look at this, this run right here, it’s up 40%, from from that point that it starts and the markets down 35.
So it goes the exact opposite direction of the s&p 500. And so that’s another piece but then you can also see as the market recovers, right, it starts to go down, unlike what you saw with the Treasury. So we didn’t actually use this during the downturn, during the pandemic downturn in February of March of last year, mainly because it was just so fast, because we kind of go step by step, you know, first we have the stop losses, and then we’re rotating into stocks that fell last, and then we’re moving into things, you know, like the extended duration treasuries, and then we would have used this, you know, if it would have continued that be a problem, we would have started to use some inverse, we’re not actually looking to make money in a downturn on the stock market portion, we’re just trying to slow down some of the descent. And by slowing down to the cent, what we’re doing is really trying to get the recovery to come back faster. And so everybody has to take a certain amount of risk in their portfolio, because we can’t predict when these things are going to happen. But we’re going to, you know, make the step by step changes throughout these downturns.
So I don’t prepare a portfolio for a downturn in advance that’s predictive, I do a reactive scenario, where I go through the steps. And these are steps that I’ve defined and honed and worked on for, you know, my 35 year career. And it worked great. I mean, we did really, really well here and our bounce was very strong, we came back much faster than the market across the board. And we did the same thing with the ESG portfolios, you know, there’s a lot of different pieces there that we can look at, too. So really, that’s the answer to that question. It’s obviously kind of a long answer for a short question, but it’s probably one of the most important things that we do is that process and kind of what we’ve learned there. As far as that goes, it then you got to go the other side, which is how to unwind all of those things. How do you unwind the Treasury pieces and get back and how do you unwind if you have an inverse? How do you unwind that and you get rid of it and go back to the market, which is a whole nother subject but, but anyway, that’s those are the basics for how it works as far as that goes.