ETF investors should be prepared for what usually happens at the end of a bull market, look to defensive investment options and consider an allocation strategy for 2020.
In the recent webcast, Don’t Predict the Next Market Decline, Prepare for It, Sean O’Hara, President, Pacer ETFs, explained that the U.S. is currently in the second longest bull market since 1930 – the last longest bull period was from 1987 through the end of the dot-com era bubble in 2000. However, it is nearly impossible to call a top to a bull market, and it can be costly for those who exit too early.
On the other hand, the average bear market has shown a historical median decline of -35% or an average plunge of -41%, or far more than the defined -20% drop, and they lasted about one-and-a-half years.
Since it is unlikely the average investor will accurately predict the tops and bottoms of a market cycle, it is important to implement a strict strategy to better navigate the markets. For example, Pacer ETFs incorporate a type of trend following strategy to provide dynamic exposure according to market shifts.
“In today’s uncertain and volatile economy, investors can be apprehensive about the market and how to navigate it,” O’Hara said. “Most people are familiar with the technology bubble in the early 2000s and the recession from 2007-2009, but there have been 25 bear markets since the Great Depression of 1929. Following a trend allows investors to be more confident in their decision making.”
O’Hara explained that trend following strategies remove emotions and speculation from the investment decision making process. Alternatively, there will be indicators that help investors participate in positive trends and avoid negative trends. The indicator may not be right every time, but the goal is to be right enough times to prevent the steepest drawdowns.
A common way to follow a trend is through the moving average, such as the 200 day simple moving average or 200 Day SMA, which is used by market analysts as a key indicator for determining overall long-term trends. Looking at the previous six bear markets, the 200-day simple moving average has acted as an early indicator of a bear market, with the majority of losses after the an Index dipped below their 200-day SMAs, producing improved risk-adjusted returns over time.
For example, the Pacer Trendpilot US Large Cap indexing methodology experienced annualized average returns of 7.02% from 1999 through September 2019, with annualized volatility of 11.61% and a maximum drawdown of -17.58%. In comparison, the S&P 500 Index experienced an annualized average return of 5.67%, a 18.95% annualized volatility and -55.25% maximum drawdown.
As a way to help investors automate the trend following strategy, Pacer has come out with the Pacer Trendpilot strategy, which is implemented through a rules-based indexing methodology found under the fund provider’s ETFs, including the Pacer Trendpilot US Large Cap ETF (BATS: PTLC), Pacer Trendpilot US Mid Cap ETF (BATS: PTMC), Pacer Trendpilot 100 ETF (BATS: PTNQ), Pacer Trendpilot European Index ETF (BATS: PTEU), Pacer Trendpilot International ETF (PTIN) and Pacer TrendPilot US Bond ETF (PTBD).
The strategy follows strict guideline with three indicators, including an equity indicator, 50/50 indicator and a T-bill indicator.
The Equity Indicator refers to when the Benchmark Total Return Index closes above its 200-day SMA for five consecutive business days, the exposure will be 100% to the Benchmark Index. From the equity position, the Index will change to the 50/50 position or the T-Bill position depending on the 50/50 Indicator and the T-Bill Indicator.
The Price Signal 50/50 Indicator refers to when the Benchmark Total Return Index closes below its 200-day SMA for five consecutive business days, the exposure will be 50% to the Benchmark Index and 50% to 3-Month US Treasury bills. From the 50/50 position, the Trendpilot Index will return to the equity position or change to the T-Bill position depending on the Equity Indicator or T-Bill Indicator.
Lastly, the Trend Signal T-Bill Indicator refers to when the Benchmark Total Return Index’s 200-day SMA closes lower than its value from five business days earlier, the exposure will be 100% to 3-Month US Treasury bills. From the T-Bill position, the Trendpilot Index will change to the equity position when the Equity Indicator is triggered. It will not return to its 50/50 position unless the Equity Indicator is first triggered.
Financial advisors who are interested in learning more about defensive investment strategies can watch the on-demand webcast here.