Hussman: Simple Trend Following a Bad Investment Strategy

Tuesday, 28 Aug 2012 09:44 AM

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Although trend-following measures shouldn’t be ignored, following isolated trends is a bad idea, economist and fund manager John Hussman writes in a note to investors.

“[S]imple trend-following schemes (like moving-average crossover rules) are unlikely to be very effective in isolation, and are not usefully applied as a top-level filter in the hope of catching market rallies without being vulnerable to downside risk,” he writes.

Generally, Hussman says, the best that popular moving-average crossover systems can accomplish is a moderate reduction in drawdown risk, while providing zero or negative incremental long-term return versus the return of a buy-and-hold strategy.

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.  

“The key issue here goes back to what I’ve always emphasized about ‘signal extraction,’” says Hussman. “Generally speaking, single indicators provide weak information because the true signal (whether about market conditions or economic prospects) is invariably confounded by random noise.”

The ability to differentiate signals from noisy observable data is typically enhanced by using a variety of indicators, he notes.

“Just as we find for economic data, market action should always be analyzed in the context of multiple indicators that capture a broad range of sectors, security types, yield spreads, leadership and so on. The information isn’t just in the obvious trends, it is also in the less obvious divergences,” Hussman says.

He adds that the trend-following components of market action have already turned negative

“Moreover, I should note that even very popular trend-following approaches such as the 200-day moving average, the ‘Golden cross’ (50-day vs. 200-day), the 34-week crossover, the 55-week crossover and others, have produced flat or negative total returns — even before transaction costs — since the April 2010 market peak,” he writes.

According to Nadia Papagiannis, an alternative analyst at Morningstar, short-term trend-following strategies are worse when there is a long-term trend, according to Investment News. Markets trending up or down favor longer-term-trend funds, she notes.

With the uncertainty about the so-called fiscal cliff, the presidential election, the European debt crisis and the slowdown in China, Papagiannis says, “In the near-term, the short-term trend followers are going to be more profitable.”

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.

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