Alpha Power Investing Newsletter

May 1, 2017

Peering into the "Dead Zone"


For the Alpha Mid-Cap Power Index strategy and The Formula strategy, the period that we refer to as the "Power Zone" wraps up at the end of May 2017. At that time these strategies will exit positions in stock indexes and move into intermediate-term treasury bonds until late October, in what we refer to as the "Dead Zone".
 
With virtually all major U.S. stock indexes in confirmed up-trends and at or near new highs - and with continued concerns about the potential for higher interest rates - some investors may feel a bit anxious about stepping out of stocks and into bonds at the end of May. The key is to remember that this move is part of a long-term, time-tested strategy. This strategy focuses not so much on current market conditions, but rather on well-established seasonal trends and also on maximizing the tradeoff between reward and risk.
 
Common Questions Regarding the "Dead Zone"
 
For this newsletter, we will use the Bloomberg Barclay's Intermediate Treasury Index as a proxy for bonds and the S&P 500 Index as a proxy for stocks, utilizing monthly total return data from the PEP Database compiled by Callan Associates.
 
Common Question #1: Do you sell stocks because you think the stock market will decline?
Answer: Not at all. In fact, in 31 of the past 41 years (76% of the time) the S&P 500 Index has showed a gain between the end of May and the end of October with an average gain of +2.3%.
 
Common Question #2: Are you confident that bonds will outperform stocks during the June through October period?
Answer: Not necessarily. In fact, in 21 of the past 41 years the S&P 500 Index has actually outperformed the Bloomberg Barclay's Intermediate Treasury Index, so it's about a 50/50 proposition.
 
Common Question #3: So, if you are not sure if the stock market will decline, nor that bonds will outperform stocks, then why automatically sell stocks and switch to bonds?
Answer: Two reasons. First, bonds tend to be far less volatile than stocks during these months and second, on those occasions when stock performance is bad during the "Dead Zone" months it tends to be "very bad."
 
Let's first consider some simple but relevant statistics regarding the performance of stocks and bonds only during the months of June through October starting in 1976.
 
Bonds: Have showed an average gain of +3.4%, a median gain of +3.6% with a standard deviation of 3.2%.
 
Stocks: Have showed an average gain of +2.3%, a median gain of +2.6% with a standard deviation of 9.6%.
 
In simple terms, bonds have tended not only to outperform stocks, but with only a third of the volatility exhibited by stocks (3.2% standard deviation versus 9.6% for stocks).
 
But the bigger answer requires an understanding of the bigger picture. No matter how well any system may perform over time, if the volatility of the fluctuations in equity is too great, an investor may become susceptible to "bailing out" at exactly the wrong time. The smoother the volatility of the fluctuations in equity, then the less negative "emotion" an investor may experience and the more likely they may be to simply adhere to their strategy over the long run.
 
The bottom line: The discipline to follow a given strategy is just as important as the rules of the strategy itself.
 
The "Dead Zone" as the "Risk Off" Period
 
As covered above, the problem with the "Dead Zone" is not that the stock market is "likely" to decline, nor even that there is a high probability that stocks will underperform bonds within this period during any given year. The real story of the "Dead Zone" can be summed up as follows:
 
"When bonds are bad, they aren't that bad, but when stocks are bad, they are very bad."
 
In the past 41 years, bonds have experienced a loss only five times during the June through October time period. The average of these losses was just -1.4%, and the worst loss was -3.3% during the extreme interest rate spike experienced in 1980. On the other hand, stocks have experienced a loss 10 times during June through October; the average of these losses was -10.5% and the worst loss was a stunning -30.2% decline in 2008.
 
The chart below displays the five worst years for both the Bloomberg Barclay's Intermediate Treasury Index and the S&P 500 Index during June through October since 1976.
 
 
The average return of the five worst "Dead Zone" periods was -1.42% for bonds and -17.72% for stocks.
 
Summary
 
There is no "prediction" built into the action of the Alpha strategies to move out of stocks and into bonds during the "Dead Zone." The action is based solely on the long established tendency for bonds to hold up reasonably well (even in a difficult interest rate spike such as the one that occurred in 1980) during the summer and early fall months and on the desire to avoid the occasional - yet potentially financially and emotionally devastating - double-digit stock market decline.
 
To learn more about our strategies, go to the Strategies and Performance page of our website at www.alphaim.net to read the brochures and fact sheets.
 

Jay Kaeppel
Vice President and Director of Research
Alpha Investment Management, Inc.
877-229-9400
www.alphaim.net
info@alphaim.net

Disclosures: Past performance is not a guarantee of future performance. Indexes are not investment vehicles. The returns illustrated above are not returns of any Alpha strategy and do not include management fees or the cost of funds, trading, or other expenses. To see the impact of these costs, please refer to the net of fees and expenses performance data for specific Alpha strategies. The illustrations above are designed to quantify the effect of certain time periods on representative market indexes.

Alpha Investment Management, Inc. is a SEC registered investment advisor. Such registration does not imply a certain skill or training and no inference to the contrary should be made. The information and opinions expressed in this document are for informational purposes only. Any recommendation or opinion made in this document may not be suitable for all investors. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security.


© 2017 Alpha Investment Management, Inc.

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