In January 1962 Warren Buffett wrote to his partners and told them when to be disappointed in him. His best years against the market, he said, would likely come when prices were falling or flat, and in a strongly rising year he would struggle to keep up. He put the bad news in writing before there was any bad news to report, because a partner who has been warned reads a lagging year as the plan at work.
The warning was tested more than once. In 1969, finding nothing cheap enough to buy, he closed the partnership and handed the money back. Thirty years later, at the height of the technology boom, Barron’s put him on its cover under the headline “What’s Wrong, Warren?” Technology shares began their collapse a few months afterward, and the question was quietly withdrawn.
The lesson usually drawn is that he was right. The more useful one is that his investors stayed long enough to find out. Cautious strategies keep their investors when the caution was promised in advance, in plain words, along with its price.
So here is my own warning, in the same spirit. Each of the eleven sectors is held while it trades above its 200-day average and moved to Treasury bills when it falls below. In a strong year that rule will usually leave the strategy behind the market, because some sectors spend part of the year in bills and because equal weighting holds less of the giant companies that lead such years. The rule also sells after a decline has begun and buys back after a recovery has started, so it gives up a little at both ends, and some declines reverse so quickly that it will have stepped aside for nothing.
What the strategy gets in exchange is smaller losses. A smaller loss takes less of the next advance to repair, and the investor who has fallen less is far more likely to still be invested when the recovery comes.
A strategy like this suits a particular investor, the one who would give up some of the best years for a milder version of the worst. An investor who needs to beat the market every year will be unhappy here, and I would rather say so now.
So expect the strategy to lag in the good years and to hold up in the bad ones. When that happens, the rule is doing what I said it would.
John