Our friend Mark asks:
“For the VTS Tactical Balanced Strategy, I don’t understand why you don’t use an inverse S&P 500 ETF instead of gold. Wouldn’t it be better in a market crash?”
(Remember our VTS Tactical Balanced Strategy rotates between stocks in “good times” and either bonds or gold in “bad times”)
Great question! I can certainly understand why that would seem to make more sense. After all, when stocks are crashing it would seem the most direct way to profit from that would be a simple inverse S&P 500 product, maybe something like SH (Proshares Short S&P 500 ETF)
And granted in a recession the odds of inverse S&P 500 outperforming gold is quite high, but the problem is, what happens when the markets don’t completely crash? What happens if it’s just a series of corrections within the context of a bull market like we’ve seen for the past 9 years since 2009?
As we’ve seen time and again in the 102 months and counting since the last recession, markets do “bounce” quite strongly from pull backs and corrections, and an inverse S&P 500 product will feel 100% of that loss.
Gold on the other hand isn’t that highly correlated to stocks, so when markets bounce and the inverse S&P 500 product gets crushed, gold doesn’t necessarily. And sometimes it even experiences gains as well.
Gold is actually a much better choice for the low end of our strategy. Here’s a comparison of our VTS Tactical Balanced Strategy, but replacing all the GLD positions with SH positions instead:
That’s substantially worse, but why is this happening?
In the context of a 9 year bull market, there will be pull backs and corrections along the way, but few and far between and for the most part they will be shallow.
If you short stocks every time there’s weakness, you’ll end up getting into inverse stock positions just as the markets are ready to bounce and recover. That’s a recipe for disaster, and a constant 9 year run of bleeding capital.
You can see it clear as day when we look at just the SH positions on their own. Remember we’re in Gold and the GLD roughly 25% of the time, when markets are their weakest:
That’s why it doesn’t work. Sure in a big recession it makes a huge profit and it’s high fives all around. But what about the other 9 years?
Investors in general usually underestimate how difficult it is to outperform in good times AND bad. On one side or the other it’s easy.
– If markets are raging higher you just ignore risk management and buy with both hands, you’re a hero.
– In bear markets, clearly you just short stocks and laugh all the way to the bank.
But in the real world, long term profitable traders need strategies that can work on both sides at once, without requiring market predictions and a crystal ball to succeed. Much harder than it sounds, which is why the majority of investors (and the majority of fund managers) won’t beat index funds in the long run.
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