The Futility Of Calling Market Tops

Posted On November 30, 2016 12:40 am

The traumatic market collapse of 2008 and 2009 has left a scar on the hearts of many an investor. Which is why it’s understandable that calling the next market top has become so popular. In fact, since 2010 there have been over 20 prominent financial experts who have proclaimed a market top and recommended selling, and going to cash in preparation of a a major bear market.

Of course all of them have been wrong, as the market has continued to climb the ever present Wall of Worry and moved higher. That’s not to say that at some point we won’t have a bear market (20% decline from highs), or even an all out crash (30%). However if you’ve been listening to the “experts” during the last few years you will have almost certainly have underperformed the markets.

A research report from Bank of America Merrill Lynch’s Savita Subramanian is very interesting. He looked at the last 80 years of market data and found that the the final 6, 12, and 24 months of a bull market accounted for, on average, 11%, 19%, and 44% of all returns during that time, respectively.

This bull market has been similar, with 38% of total returns from this bull market occurring over the last two years.

That makes sense since historically the market has risen, on a year-to-year basis, 70% of the time. Now of course volatility during even the good years can be extreme, as anyone who was around in January of 2016 can attest. However, the point I’m trying to make is that the key to avoiding massive losses isn’t necessarily to sit on the sidelines and wait for a crash that may still be years away, and that NO ONE can actually predict.

Rather the key to preventing massive drawdowns is to buy what’s already cheap. Take energy for example, oil stocks like Enterprise Products Partners (EPD), and Holly Energy Partners (HEP), two super high quality names in the midstream MLP industry, have already been beaten way down. So a 15%, 20%, even 30% market crash, while likely to mean lower prices, would likely mean a mere 10% to 15% decline compared to much higher losses in richly priced shares.

In fact, just to prove the above point, I’m currently running an experiment, of building out a vast, diversified portfolio of quality dividend growth names.

The key determinant? The company recently experienced a strong sell off (such as from an earnings miss), or recently hit a 52 week low. Thus far I’ve located 98 such companies, and will expand the portfolio out to 200.

Why such a ridiculously diversified portfolio, one that’s practically a custom index fund? To prove the point that even with such a broad portfolio, mostly filled with blue chip names that everyone has heard of, you can still beat the market, in both good times and bad, just by buying what’s on sale, as well as buying on all 10% dips.

Thus far the annualized total returns for this Value Dividend Growth Index, aka DVGI, is 2.43% vs 0.93% for the market (investing the same amount into SPY at the time I bought those stocks).

Though the data is hardly significant at this point (1.5 weeks of performance so far), I’m not at all surprised that DVGI is already beating the market. After all, when a blue chip like Tyson Chicken (TSN) falls 15% on a solid earnings report that misses expectations, well that’s shooting fish in a barrel. The same with Medtronic, or Southwest Airlines, or Union Pacific, all of which have gotten crushed this quarter when they disappointed analysts.

In the coming weeks, months, and years, I’ll continue to update you all on how VDGI does, just to show that a simple, rules based, and logical approach to solid, fundamental dividend growth investing is all that’s needed to beat the markets, and thus 95% of the “pros” on Wall Street.

Value Dividend Growth Index: Update 1

Holdings: 98

Yield 4.1% (S&P 500 2.0%)

Projected Dividend Growth: 8.5% (S&P 500 6.1%)

Projected Total Return: 12.6% (S&P 500 9.1%)

About author

Dividend Sensei
Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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