A perfect comeback

It was amazing! It had never happened before. It was the third quarter, and the New England Patriots were down 28 to 3 to the Atlanta Falcons. An hour later, after scoring 31 unanswered points, the Patriots were the champions of Super Bowl LI.

What a comeback! Three past Super Bowl teams have come back from 10-point deficits but never 25.

There have been many great comebacks in history. And they have not all been in sports. They occur daily in our national and personal lives.

What sets apart a team, a nation, or a person that can mount a comeback from adversity from one that cannot? Psychologists tell us that it is mental toughness.

Mental toughness is a part of the inner game, as contrasted to the outer game dominated by the physical condition of the opponent. Mental toughness is, according to Sports Performance Consultant Dr. Alan Goldberg, “composed of handling pressure, dealing with mistakes, managing psych-outs & intimidation, maintaining concentration, withstanding momentum shifts and being able to come back when your back's against the wall.”

If you watched the Super Bowl this weekend (according to Nielson, 72% of U.S. households were tuned in) you heard the commentators speaking of this aspect of the game. The Patriots did not let the pressure of being down 25 points cause a defeatist attitude. They had made mistakes, momentum had shifted back and forth between the teams, but they did not give in.

Winning quarterback Tom Brady (a fellow University of Michigan alumnus) talked about how they were able to come back. Their coach taught them that every play could be a Super Bowl moment. By focusing on the now, the carrying out of each play, instead of what had happened in the uncontrollable past, comebacks were always possible.

We see this in the world of finance as well. Professional traders have developed the mental toughness to deal with the losses that the financial markets can often deliver. They have learned when to stick with their original principals on a long-term trade and when to cut their losses quickly on a short-term opportunity. If they don’t learn this, they do not survive in the profession. They have to have this mental toughness.

Part-time investors rarely develop this level of mental toughness. They are much more influenced by the emotion of the trade. When a loss grows, they will often hold on because they do not have a game plan that accounts for it.

Intermediate- or long-term trading requires the resolve to hold one’s position as long as it remains consistent with the original game plan. If the investor does not understand this, when their loss grows too large, they will often abandon the trade at the wrong time—just before the trade turns around. This tendency is the real reason why so-called buy-and-hold investing does not turn out as planned, and is why most investors cannot stick with buy-and-hold investing.

Adopting disciplined, rule-based strategies can level the playing field between the professional traders and other investors. They eliminate the emotions because they are based solely on the numbers. Every decision to buy and sell is determined by a computer program that is based on time-tested rules that have been quantified and tested in different market environments to eliminate any guesswork.

At Flexible Plan Investments, we manage our clients’ money in accordance with these rule-based strategies. We offer more than 100 of them.

I noticed one that has been making a comeback of its own, as it was up about 12% in January. Self-adjusting Trend Following (STF) has been a popular strategy since it gained more than 50% one year. Then it fell out of favor as it slumped more than 20% over the next year and a half. It seemed to be on the ropes.

But now STF and Volatility Adjusted NASDAQ (a similar strategy [up about 10% YTD] that had not tumbled nearly as much but which also trades the NASDAQ 100 Index) are making a comeback. How did they do this?

The computer provides the mental toughness to focus on the necessary trades in the here and now. It has no memory of the past to cause emotional discord.

As Dr. Goldberg stated, “So when you're hopelessly down and out, the way that you get yourself back in the game or match is NOT by focusing on how far behind you are and how badly you're being beaten, (this will only cause you to lose the mental game), but by keeping your concentration on one point/play at a time in the NOW. Comebacks happen when you refuse to quit and narrow your focus to only what's in front of you, one play at a time.”

That’s just what a disciplined, computer-based strategy in a separately managed account can do for you.

The stock market staged its own comeback after a couple of down days last week. While the S&P still remains below the new high registered a couple of days after the inauguration, the Russell 2000 managed to make a new set of highs last week.

Similarly, the bond market, which had been decimated after the election, has turned around nicely since the December rate increase by the Federal Reserve. This may seem counterintuitive, but as we stated in early editions of the Hotline, the market had already priced in the rate hike, and as the market often does, it overreacted. The result is a comeback in bond prices.

The U.S. dollar has been moving in an opposite manner. It rallied mightily after the election, only to peak at the end of December. The resulting move lower not only made U.S. goods more attractive to non-U.S. buyers, but it also propelled gold, which was in need of a comeback, into a 5%-plus rally this year.

Looking into the future, while economic reports have been mixed to slightly negative overall, earnings reports have provided fuel for a move higher. So far, this contradictory, dual focus of investors has led to a sideways direction in stocks.

Investor sentiment remains mixed as well. In the latest American Association of Individual Investors’ survey, 32.8% were bullish, 33.03% were neutral, and 34.17% were bearish. You don’t get more divided than that!

Our Political Seasonality Index is pointing to lower stock index values between now and February 10, and then a sell again from February 15 to 22. At that point, a sustained buy period continues until mid-March (3/16). February tends to be a flat to down month, especially in years after an election when a Republican challenger wins.

Finally, our intermediate-term market-timing strategies remain fully invested. They have been in this state since before the election. And we have not had a down day equal to or greater than 1% in that time period.

On balance, this all suggests to me that stocks are likely to remain in a sideways to rising state for the foreseeable future, but high valuation, overbought technicals, and political uncertainty could cause the landscape to change suddenly.

We’ve been in a deep freeze here in Michigan for about a week. This morning it was below 10 degrees. Now it’s over 40. Things can change quickly. What a comeback!

All the best,

Jerry