Ask Colin

Are we in the early or late stage of phase two of the bull market (December 2014)?

The detailed question was:

I read with interest each week your market phase analysis.  You are confident (as am I) that we are now in "phase two - increasing earnings".   Do you have any method or opinion on whether we are in the early or late stages of this phase?


No. It is usually the longest of the three phases, but beyond that every cycle is different. While there are clear bull/bear cycles in markets, they are not predictable in length in my experience. Hence, my strategy is  to hold through phase two and when phase three has clearly arrived, begin to reduce exposure.  


A follow up question was:


The final point in your answer however highlights something that has intrigued me for years (listening to your presentations). When the rampant speculation / irrational exuberance stage begins why not stay in there and reap the benefits for as long as possible?  Of course, shorten your stops from say 20% to 10% but let stocks run for as long as is feasible.  Or, is that exactly what you do?


Jamie Dimon tried that in 2007-08 – his famous quotation that the music was still playing so he had to get up and dance. Cinderella left the ball late, but got out before midnight (albeit leaving one slipper behind).


The central task in investing  is managing risk rather than trying to maximise returns. A sound strategy with good risk management builds wealth over time – safely. My market exposure strategy is to be in bull markets and out of bear markets. I aim to get in early and get out early. My worst result was 1987 when I had only taken out 75% of my capital by the day of the crash. You never know when the end will come of how sudden the fall may be. My capital throws off more income than I can ever spend, so why take big risks?


However, that is my approach and as I say often there are many ways to make money in the markets, depending on knowledge and skill level borne out of experience. If you think you have the skills and experience to follow an alternative and higher risk plan, then I would not discourage you to from trying, so long as your risk management is sound.


By the way, my stops are not arbitrary, they are dictated by the market – where I am wrong about what I expect to happen when I buy a stock. I have a real problem with then placing stops at an arbitrary higher level. They are then in a place where what I expected to happen is still happening, why would I sell there? I gave a presentation at the ATAA conference in Brisbane a few years ago demonstrating this. I demonstrated that higher stops that break the logic of your investment plan may actually tend to increase the chance of being stopped out prematurely and may also increase losses.