Where you want to be is always in control, never wishing, always trading, and always, first and foremost protecting your butt.”

“I believe the very best money is made at the market turns.

Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle.

Well, for twelve years, I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.”

“At the end of the day, the most important thing is how good are you at risk control.”

“The whole trick in investing is: “How do I keep from losing everything?”

— Paul Tudor Jones

[drizzle]Early each month, I like to look at valuation metrics.  They remain high.  Today, you’ll find the most recent charts (Buffett’s favorite, median P/E, and a few other interesting links when you click the orange On My Radar link below.

We’ll also take a look at what valuations are telling us about probable 7- and 10-year forward returns.  I believe risk is most when we feel it least and the risk is least when we feel it most.  Today, we feel it least.

I believe there are several bubbles in place today: one is in fixed income (a debt mess here, there and everywhere – it will require restructuring) and another is in passive equity investing.  My friends at 720Global call it “Passive Negligence.”  You’ll find some thoughts around that thinking as well.

We humans are herd beings.  In 1999, it was tech.  Now it’s bonds, high yield debt and passive index funds.  What I find concerning, and you may as well, is that 75% of all the money will be in the self-directed hands of pre-retirees and retirees (by 2020, according to BlackRock).

My kids have time to dollar cost average over many years.  So what if forward returns over the coming seven years (as you’ll see today) are a negative -3.10%.  That means a big sell-off, which is big opportunity for dollar cost averaging.  At 55, I have less time, but for my friends on the front-end of the baby boomer curve, well, they just don’t have the years it will take to overcome another 50% hit.

Can you imagine the panic that will ensue when the next recession right-hook hits stocks square in the mouth?  Behavior will not change.  The majority of investors will flee to safety.  They’ll sell when they should be buying and they’ll buy when they should be selling.

You don’t need to take that hit…

Tony Robbins interviewed one of the best traders of all time, Paul Tudor Jones.

I teach an undergrad class at the University of Virginia, and I tell my students, “I’m going to save you from going to business school.  Here, you’re getting a $100k class, and I’m going to give it to you in two thoughts, okay?  You don’t need to go to business school; you’ve only got to remember two things.  The first is, you always want to be with whatever the predominant trend is.

My metric for everything I look at is the 200-day moving average of closing prices.  I’ve seen too many things go to zero, stocks and commodities.  The whole trick in investing is: “How do I keep from losing everything?”  If you use the 200-day moving average rule, then you get out.  You play defense, and you get out.”

Tony then asked Paul, “Since asset allocation is so important, let me ask you:  If you couldn’t pass on any of your money to your kids, but only a specific portfolio and a set of principles to guide them, what would it be?”

Paul answered, “I get very nervous about the retail investor, the average investor, because it’s really, really hard.  If this was easy, if there was one formula, one way to do it, we’d all be zillionaires.  One principle for sure would get out of anything that falls below the 200-day moving average.”

Learn how trend following strategies can help you participate and protect.

Ned Davis Research (NDR) looked at optimal moving average (“MA”) data since 1901.  NDR found that the 200-day MA was most optimal over the entire period, but the 100-day MA was the better moving average in the period that ended in 1981.  OK – use something and stick to it.

11-04-01

Source: Ned Davis Research

As you can see in the next chart, by and large, you catch the majority of the trend and avoid the majority of the downtrend.

11-04-02

The point is you can put in place a process that can work.  The key is finding processes you can have the conviction and discipline to stick to.

As a quick aside: At CMG, we run trend following trading strategies.  If you are an advisor client of ours, please understand that the weekly OMR is about global macro-economic issues.  The intent is to stimulate ideas and to present ideas and commentary in a way that can help you educate your clients.  I know you know this material.  OMR sets the base case for the importance of risk management.  Our strategy material, available to you separately, can better explain our strategies and where they might fit in your client portfolios.

My strongest advice is to diversify to a handful of trend following trading strategies.  This goes for both the equity markets and fixed income markets.  Mohamed El-Erian is telling you to raise some cash.  I think El-Erian is spot on.

11-04-03

I’m sure you have many clients with equity positions they have held for years and they intend to hold for many more.  For such positions, consider out-of-the money put options to hedge against declines of greater than 20%.  Overcoming a 20% decline takes a 25% subsequent return.  Overcoming 50% takes a 100% return.  And that -75% post-tech bubble wreak?  300%.  It’s all in the math:

11-04-04

Source: Crestmont Research

Click here for an education piece we wrote titled, The Merciless Math of Loss

I’m on record calling for a 40% to 60% market correction.  Best guess is within 12-18 months.  The problem?  Valuations, the lowest yields in history, record high debt, near record high margin debt and an aged economic cycle.  Recessions come one or two times a decade.  The last one was eight years ago.  If you think the Fed is all powerful, just remember what Greenspan was saying post-2008.  His data was “flawed.”  Right!

To get to the other side of the next dislocation, you need to overweight to strategies that can play defense and get out.  Investing is about compounding over time.  Minus 50 torpedoes the math.  If you do nothing else, listen to Paul Tudor Jones.  The 200-day moving average rule isn’t perfect but it’s pretty darn good.  It helps you systematically raise cash and put you in an enviable positon to buy the bargains the next correction will present to you.

Let’s look at valuations.  You’ll also

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