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Interesting vs. Actionable

“Distinguishing the signal from the noise requires both scientific knowledge and self-knowledge.” – Nate Silver

Records are made to be broken. We saw that in spades last week.

For the first time in history, the S&P 500 declined 9 days in a row while the Volatility Index (VIX) rose for 9 straight days.

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The S&P 500’s 9 consecutive days of losses has only happened a handful of times in history, last occurring in December 1980.

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The 9 straight up days for the Volatilty Index (VIX) is a new record.

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Are these stats interesting? Yes.

Are they actionable? No. Certainly not in their current form and perhaps not in any form.

There are many interesting things that go on in markets on a daily basis, but few of those warrant an actual buy/sell decision. Because these streaks are rare (the S&P has only declined 6 or more consecutive days 127 times since 1928), there is little precedent for what will happen next. Making a wholesale change in your portfolio based on small samples probably isn’t the best idea for a long-term investor.

But what do the odds suggest? Good question. At the very least we can evaluate the evidence to dispel some myths. Many seem to be saying that the long string of declines is an omen of impending doom. Surely the market would not go down 9 days in a row, they say, unless something bad was about to happen.

Is that in fact the case?

No.

When the S&P has a long string of declines in the past (6 or more consecutive days), what we find is the following:

a) the market tends to go up,

b) with a higher average return from 3 months to 12 months forward, and

c) with a higher probability of positive returns.

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Interesting? Yes.

Actionable? I’m still not sure. It certainly disproves the myth that long streaks of negative returns are likely to be followed by more negative returns. But whether it’s actionable depends on many factors: 1) whether you are an investor or a trader (what’s your time frame), 2) how you’re currently positioned, 3) how you interpret the data (is it statistically significant or due to chance), 4) how does the data interact with other market factors/studies, and 5) what do you intend to do with it (what exactly is your strategy in using the data and will you stick with it?).

I’ll spare you the details of analyzing each of these factors and just say the hurdle is exceedingly high in turning interesting information into something actionable.

Does that mean it is entirely useless? Not necessarily, because even if we don’t act on it we can still use it to prevent ourselves from doing something stupid:

  • For a trader, that would mean going short or selling longs on the belief that a long down streak means a likelihood of further declines. We know from the data it means no such thing and the odds actually seem to favor the opposite.
  • For an investor, that would mean selling down your equity allocation or putting your dollar-cost-average plan on hold. We know from the data that long streaks of declines are not valid reasons for long-term investors to sell. If anything, they seem to offer an opportunity (on average) to add at lower prices.

And so perhaps we have uncovered something here that is both interesting and actionable, even that “action” is really “inaction,” preventing you from doing harm.

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Related Posts:

First, Do No Harm

Overbought, Oversold, and the Great Paradox in Markets

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Charlie-Bilello

Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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