ARRIVING

FASHIONABLY LATE TO THE PARTY

A Message from the

Investment Management Department

October 2014

Authored by Rob Brown, PhD, CFA

I. INTRODUCTION
Perhaps, as an investor, you need the returns offered by the stock and bond markets to achieve your
financial objectives. But after having lived through the disastrous bear markets of 2001 and 2008
(when stocks1 fell -45% and -51%, respectively2), you dont feel that you can expose your life-savings
to such volatility ever again. Tactical Asset Allocation strategies (hereafter referred to as TAA) are
often presented as a solution to this conundrum. Their primary objective is to mitigate loss during
the most severe bear markets, with a secondary objective of delivering an attractive portion of the
markets return during their bull phase.
To achieve this objective, TAA strategies must both get-out and then get-back-in again, and do so
with sufficient accuracy or timeliness. The relevant question becomes Just how accurate do the
decisions made by TAA portfolios have to be in order to add value? To answer this question, lets
consider the history of bear markets, both for the stock market and for the bond market.

II. THE HISTORY OF STOCK BEAR MARKETS

The table below shows the history of bear markets for the U.S. stock market.3
History of Bear Markets For Stocks
Loss (in %)

Lasted
(in months)

1876

-34.09

15

3/31/1876

6/30/1877

1893

-25.17

1/31/1893

8/31/1893

1903

-25.96

13

9/30/1902

10/31/1903

1907

-34.06

14

9/30/1906

11/30/1907

1913

-25.25

24

10/31/1912

10/31/1914

1917

-27.90

13

11/30/1916

12/31/1917

1920

-26.37

20

10/31/1919

6/30/1921

1931

-83.66

34

8/31/1929

6/30/1932

1937

-49.82

13

2/28/1937

3/31/1938

1969

-29.18

19

11/30/1968

6/30/1970

1973

-42.72

21

12/31/1972

9/30/1974

1987

-29.59

8/31/1987

11/30/1987

2001

-44.73

25

8/31/2000

9/30/2002

2008

-50.95

16

10/31/2007

2/28/2009

Median bear market

-31.83

16

Average bear market

-37.82

17

Bear Market

Start Date

End Date

86.4% is percentage of time the market spends in bull markets for stocks
8.71 years is average length of bull markets for stocks
17.07% is average annual compound return during bull markets for stocks

The average bear market lasts for 17 months and delivers a -38% loss (even after dividends are
included). The average time period between the end of one bear market and the start of the next
is nine years. When the market is not experiencing a bear market, the average annual return is 17.1%.
The stock market spends about 14% of its time in a bear phase.
Lets now return to our question Just how accurate do the decisions made by TAA portfolios have
to be in order to add value?

III. IMPACT OF LATE DECISIONS FOR TAA IN STOCKS

The following table4 shows three different results:
What a hypothetical Buy & Hold investor would experience, just buying the U.S. stock
market and never selling.
What a hypothetical TAA investment manager who always got out of the stock market
at its peak and then got back in again right at its trough would expect. Essentially
getting-out and then getting-back-in at the exact perfect point in time.
What a hypothetical TAA investment manager who was always late to the party would
experience. In other words, they didnt have a crystal ball, and as a consequence could
only get out of the market after a bear market had already begun and could only get
back in again only after a new bull market had ensued.
Stocks Arriving Late And Still Adding Significant Value
Allocating between
stocks and . . .
Always In
In the stock market 100% of the time
Perfect Timing
Get out of the stock market at the exact beginning
of each bear market and back in at the exact start
of each bull market

Return
(in %)

Volatility
(in %)

Return per unit

of risk

8.86

16.53

0.54

Cash

15.14

13.84

1.09

Bonds

15.00

13.97

1.07

Always Late
Get out-of the stock market "X" months after the bear market has already begun and back-into the stock market
"X" months after the next bull market has started
1 month late

2 months late

3 months late

4 months late

5 months late

6 months late

Cash

13.80

13.37

1.03

Bonds

11.93

13.16

0.91

Cash

11.77

13.15

0.89

Bonds

12.69

13.35

0.95

Cash

11.93

13.16

0.91

Bonds

12.03

13.29

0.91

Cash

11.81

13.12

0.90

Bonds

11.92

13.25

0.90

Cash

11.77

13.15

0.89

Bonds

11.95

13.27

0.90

Cash

11.10

13.25

0.84

Bonds

11.34

13.37

0.85

Over the very long run5, the U.S. stock market earned an average annual compound return of 8.86%
with a volatility or risk of 16.53%.6 If the TAA investment manager made every single decision exactly
right, getting out of the market at its peak and back in again at its trough, the return would climb to
15.14% and the risk would fall to 13.84%.7 This perfect-foresight TAA manager would deliver a 102%
improvement in the investors return-per-unit-of-risk.
The critical point to draw from this table is that TAA managers can get it remarkably wrong and could
still add value. In fact, they can arrive at the party as much as six months after it has begun, depart six
months after it ended, and could still provide benefit.
For example, if the TAA manager got out of the stock market three months after each bear market
began and then only got back in again three months after the next bull phase had ensued, the
return would climb to 12.03% and their risk would fall to 13.29%, resulting in a 69% improvement in
return-per-unit-of-risk.8 If the TAA manager was even slower, getting out and then back in again, six
months after the bear began and subsequently ended, they would still, on average have added 2.48%
in additional return per year.8 This is remarkably encouraging for it relieves the TAA investment
manager from having to know the future with unrealistic accuracy. The story for TAA for the bond
market is remarkably and quite encouragingly similar.

IV. HISTORY OF BOND BEAR MARKETS

The table below shows the history of bear markets for the U.S. bond market.9
History of Bear Markets For Bonds
Bear Market

Loss (in %)

Lasted
(in months)

Start Date

End Date

1914

-7.34

6/30/1914

8/31/1914

1931

-6.00

7/31/1931

1/31/1932

1969

-6.82

15

9/30/1968

12/31/1969

1979

-15.78

6/30/1979

2/29/1980

1981

-14.79

15

6/30/1980

9/30/1981

1984

-6.86

1/31/1984

5/31/1984

1987

-9.23

2/28/1987

9/30/1987

1994

-7.96

1/31/1994

10/31/1994

1999

-6.32

12

1/31/1999

1/31/2000

2003

-6.38

5/31/2003

7/31/2003

2013

-7.27

17

7/31/2012

12/31/2013

Median bear market

-7.27

Average bear market

-8.61

94.4% is percentage of time the market spends in bull markets for bonds
12.36 years is average length of bull markets for bonds
6.49% is average annual compound return during bull markets for bonds

The average bond bear market lasts for nine months and delivers a -9% loss (even after interest
payments are included). The average time period between the end of one bond bear market and the
start of the next is twelve years. When the market is not experiencing a bear market, the average
annual bond return is 6.5%. The bond market spends about 6% of its time in a bear phase.
Once again, lets now return to our question Just how accurate do the decisions made by TAA
portfolios have to be in order to add value?

V. IMPACT OF LATE DECISIONS FOR TAA IN BONDS

The following table4 shows three different results:
What a hypothetical Buy & Hold investor would experience, just buying the U.S. stock
market and never selling.
What a hypothetical TAA investment manager who always got out of the stock market
at its peak and then got back in again right at its trough would expect. Essentially
getting-out and then getting-back-in at the exact perfect point in time.
What a hypothetical TAA investment manager who was always late to the party would
experience. In other words, they didnt have a crystal ball, and as a consequence could
only get out of the market after a bear market had already begun and could only get
back in again only after a new bull market had ensued.
In this example, the TAA manager is actively asset allocating between bonds and cash with the
objective of avoiding the periodic bond bear market.
Bonds Arriving Late And Still Adding Significant Value
Return
(in %)

Volatility
(in %)

Return per unit

of risk

5.39

4.61

1.17

6.47

4.16

1.56

Always In
In the bond market 100% of the time
Perfect Timing
Get out of the bond market at the exact beginning of
each bear market and back in at the exact start of each
bull market
Always Late
Get out-of the bond market "X" months after the bear market has already begun and back-into the bond
market "X" months after the next bull market has started
1 month late

6.26

4.18

1.50

2 months late

5.74

4.08

1.41

3 months late

5.63

4.06

1.39

4 months late

5.49

4.09

1.34

5 months late

5.39

4.08

1.32

6 months late

5.39

4.09

1.32

Over the very long run5, the U.S. bond market earned an average annual compound return of 5.39%
with a volatility or risk of 4.61%.6 If the TAA investment manager allocating between bonds and
cash made every single decision exactly right, getting out of the bond market at its peak and back in
again at its trough, the return would climb to 6.47% and the risk would fall to 4.16%.7 This perfectforesight TAA manager would deliver a 33% improvement in the investors return-per-unit-of-risk.
Once again, the TAA manager allocating between bonds and cash with the objective of mitigating
their clients exposure to bond bear markets can get their decisions remarkably wrong and still
add value. As shown in the table above, getting out of bonds three months after the bond bear
market has already begun and then getting back in again, also three months late, still results in a 19%
improvement in return-per-unit-of-risk.

VI. CONCLUSIONS
TAA investment managers dont have crystal balls. They cannot predict the future.10 They have
no ability to get out of the market before a bear market begins and then back in again before the
subsequent bull market ensues. But this lack of foresight does not prevent them from adding value.
They can make their exit and re-entry decisions as much as six months late and could both increase
return and reduce risk at a statistically significant level.

DISCLOSURES
United Capital Financial Advisers, LLC (United Capital) provides financial guidance and makes
recommendations based on the specific needs and circumstances of each client. For clients with
managed accounts, United Capital has discretionary authority over investment decisions. Investing
involves risk and clients should carefully consider their own investment objectives and never rely
on any single chart, graph or marketing piece to make decisions. The information contained in this
piece is intended for information only, is not a recommendation to buy or sell any securities, and
should not be considered investment advice. Opinions expressed are current as of the date of this
publication and are subject to change. Also, opinions expressed are those of the author and not
necessarily endorsed by United Capital. Certain statements contained within are forward-looking
statements including, but not limited to, predictions or indications of future events, trends, plans, or
objectives. Undue reliance should not be placed on such statements because, by their nature, they are
subject to known and unknown risks and uncertainties. All data are from outside sources believed to
be reliable. United Capital has not independently verified information and makes no warranty as to
the accuracy or completeness of the outside data. There are no investment strategies that guarantee
a profit or protect against loss. TAA strategy is not for every investor due to its higher tax liabilities.
Active trading typically increases the tax costs associated with a portfolio. Higher tax rate paid on
short-term capital gains is a permanent cost difference that cannot be recovered. Transaction costs
are also likely to be higher in a TAA strategy and will almost certainly exceed those of a traditional
indexed approach. The degree of outperformance that a TAA strategy provides must factor in the
incremental tax and trading costs relative to a more strategically managed portfolio. Given those
costs, the degree of outperformance of a TAA strategy relative to an indexed strategy may need to
be measured by hundreds of basis points on a pre-tax basis simply to break even over a period of
years. Despite periodic pitfalls that may occur using this strategy, investors must be committed to
riding through those periods of underperformance in order to let the strategy work. Likewise, while
steps can be taken to manage taxes, investors may need to be willing to pay a bigger tax bill due to
the nature of a TAA strategy. TAA may require a complete market cycle to be beneficial. As such,
investors should be committed to the strategy and be prepared to not shift gears mid-stream in
response to short-term results. Advisers must reconcile this type of strategy with a focus on tax and
trading costs, as these friction costs are a true drag on wealth accumulation.

DEFINITIONS
S&P 500: An index of 500 stocks chosen for market size, liquidity and industry grouping, among other
factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the
risk/return characteristics of the large cap universe. Companies included in the index are selected by
the S&P Index Committee, a team of analysts and economists at Standard & Poors. The S&P 500 is a
market value weighted index each stocks weight is proportionate to its market value.

FOOTNOTES
1. Throughout this article, stocks are represented by the S&P 500 Index. All returns are total
returns, including both capital appreciation and all dividends. All data was provided by Global
Financial Data, San Juan Capistrano, CA on October 3, 2014. Returns are nominal, before
adjustment for inflation.
2. Based on month-end data, measuring peak to trough.
3. Table spans the time period 12/31/1869 through 10/2/2014. Based on month-end data only.
Bear markets are defined as the market having fallen at least -25% as based on total returns
with respect to the high-water-mark over the preceding 36-month long rolling window. Each
bear market is measured from peak to trough. Returns in this table have not been annualized,
unless otherwise explicitly stated.
4. Statistics ignore any and all trading or frictional costs of any kind. Only month-end data is
used. Cash is defined as U.S. Treasury Bills. Bonds are defined as 50% 10-Year U.S. Treasury
Bonds and 50% Moodys AAA-Rated Long-Term Corporate Bonds with monthly rebalancing.
All data was provided by Global Financial Data, San Juan Capistrano, CA on October 3,
2014. Returns are nominal, before adjustment for inflation. All returns in this table have
been annualized and are presented as geometric mean returns. Volatility is measured as the
annualized standard deviation of monthly total returns. Return per unit of risk is defined
as geometric mean return divided by standard deviation. Table spans the time period from
12/31/1869 through 10/2/2014.
5. Table spans the time period 12/31/1869 through 10/2/2014.
6. Volatility is measured as the annualized standard deviation of monthly total returns.
7. Assuming the TAA manager allocated between stocks and cash.
8. Assuming the TAA manager allocated between stocks and bonds. Getting out of the stock
market exactly three months after the bear market had begun and got back into the stock
market three months after the next bull phase and started.
9. Bonds are defined as 50% 10-Year U.S. Treasury Bonds and 50% Moodys AAA-Rated LongTerm Corporate Bonds with monthly rebalancing. All data was provided by Global Financial
Data, San Juan Capistrano, CA on October 3, 2014. Returns are nominal, before adjustment for
inflation. Table spans the time period 12/31/1869 through 10/2/2014. Based on month-end
data only. Bear markets are defined as the market having fallen more than -6.000% as based
on total returns with respect to the high-water-mark over the preceding 36-month long rolling
window. Each bear market is measured from peak to trough. Returns in this table have not
been annualized, unless otherwise explicitly stated.
10. It is impossible to have perfect timing.