Why Trend Following is Your Only Hope for Investment Survival

Buy and hold. Stocks for the long run. Diversify. These investment mantras were gospel during the great bull market of the 80s and 90s.

Drinking this Kool-Aid will get you slaughtered today.

There is no freaking way I would “buy and hold” anything right now. Too dangerous. Buy and hold hasn’t worked over the past ten years, and it’s unlikely to work for the next ten. We’re in a secular bear market, and these things take time…usually 15 to 20 years…to run their course.

View the full INDEX:.SPX-E chart at Wikinvest

No doubt, we are in uncharted financial waters right now. Anyone who says they 100% know what’s going to happen next is lying, or dilusional.

We’ve got historic deleveraging taking place, as unprecedented debt levels are slowly paid down. In the meantime, we’ve got the US government, among others, running the printing presses at full steam, and tossing boatloads of money down rat holes like Government Motors and socialized medicine.

The foundation of the system has been permanently rocked, and stability, or even just the illusion of it, won’t be back anytime soon.

With the Fed’s printing press (an irresitable force of hyperinflation) battling massive deleveraging (an immovable deflationary object), the crux of any investment thesis today starts with “inflation, or deflation?“

There’s no shortage of arguments on both sides, many made by folks much smarter than I. For awhile, I was reading them until my head spun…first I’d read a very well thought out argument on why hyperinflation will win out…then I’d read a perfect counterargument for the deflation case.

So I thought – what the heck can a guy like me do, if these smart dudes can’t reach the same conclusion themselves?

Then it hit me – trend following.

If gold and commodities go up – get in those vehicles, because the market is screaming “inflation”! Gold at $1100 could go much, much higher…real, real fast.

On the other hand, gold still has not decisively broken through $1000. It could very well retest it’s lows below $700. So if it breaks down below, say, $900 – that’s the market telling us that inflation is not in the cards…at least not yet.

Early this week, gold stocks hit a 3-week low…so I sold all of them. And I’ll stay out until they once again “break out” to the upside. That’s the only way I can see to play these insane markets – buy the breakouts, and follow your stops. It’s OK to have a hypothesis, but don’t wed yourself to it. If the market says you’re wrong…then you probably are!

My friend Brian Hunt (editor-in-chief of The Daily Crux, an excellent investment website) made a great point to me on Friday about investing in China. Nobody knows what’s going to happen in China. Some think it’s a trainwreck waiting to happen. Others think China will be just fine, still the growth story of the 21st century.

So what’s an investor to do? Watch the price of copper, he says. As long as copper’s doing fine, that means China’s doing fine. Let Dr. Copper show you the way.

To facilitate my trend following strategy, I’ve pared my investment assets down significantly. I used to own 40-50+ different stocks, a few currencies, a few commodities…if something looked good in one of my many newsletters, I bought it!

Then I learned during the Great Deleveraging of ’08 that diversification does not prevent bad things from happening. Overnight, the correlation of almost all assets went to 1, and everything dropped 40% in a matter of 6 months!

Because I believe the inflation/deflation question is the only important one, I only need a few asset classes to play it. That makes trend following much, much easier for an armchair investor like myself – get into positions and back out quickly – no problem.

Remember the market is the judge and jury combined, the final arbiter of your investment decisions. So let’s listen to what it’s telling us in the turbulent years ahead…after all, the trend is our friend! And this friend may be our only lifeline to investment survival right now.

Last week in this spot, I mused:

It looks like the caution I expressed last week was warranted…commodities got hit hard across the board this week.

I exited all positions on Monday morning, after seeing the rough start to the week – that was enough to chase me out of all positions. On Thursday, I did reinitiate an Australian dollar position, after reading how the Reserve Bank of Australia was working very hard to keep their currency down in the month of May.