Why I Quit Investing in the Stock Market (and When I’ll Start Again)

I have a confession to make…

I quit investing in the stock market last year.

May 2021, to be exact. 

That might seem absurd to you. 

Markets had just been screaming higher in 2020… the meme stock craze had just inspired every 12 year old with a cell phone to begin trading stocks… market indices were hitting all time highs each month…

But I saw what was happening and I decided I would step out of the casino for a little while.

More specifically, I stopped the moment I saw the orange line in the chart below cross above 1.

Well. That’s not exactly true. 

Actually what I just said is a baldfaced lie.

More like… When I saw the orange line on the chart above shoot above 1…

I backed off the throttle on investing in the S&P 500. 

I knew it was time to go “risk off.” 

See, every month I put aside a hefty chunk of my income. You should too.

Before May 2021, about 80% of it went to passive index funds that mainly invested in the S&P 500. 

After May 2021, I dialed it down significantly. 

I began putting only about 10% toward passive index funds. I also repositioned my whole portfolio so that I was only ever about 50% to 55% invested in stocks, at maximum. (Meaning: I sold some stuff and moved it elsewhere.)

The rest of the money? 

I put some in crypto. Some of it went toward my home. A big chunk went into investing directly in a local business. Some of it went into preferred stocks ($PFF) and TIPS bonds ($STIP). I put some into individual stocks or strategies I want to test when I see a good opportunity. And every day I put $10 into $DTD and $TDIV as part of the Finance Daddy $10 Challenge.

But still…  

I put most of it in cash, where it still is today. 

And it’s going to stay there until the chart I just showed you, the MAC Indicator, tells me it’s time to be “risk on” once again. 

So what is the MAC Indicator? And why am I basing my investing decisions on it?

Let’s get right into…

The Best A.A. Meeting You’ll Ever Have

Now, this is the second installment in a series about Asset Allocation... 

Which is a fancy way of saying “what you should be investing in” and “how much you should have invested in each kind of asset.”

There’s a famous misconception, often used by fund and asset managers to get ahold of your money, that "90% of your return can be explained by your asset allocation."

The misconception comes from a 1986 study that stated the mix of stocks, bonds, and cash determines 93.6% of your portfolio’s volatility. 

(Volatility is often called a measure of “fear” but it’s more like a measure of how much the price of something wiggles around in a given time. The more volatile, the more wiggly. The more wiggly, the less certain we can be of something’s future direction.)

Truth be told, Asset Allocation and its kissing-cousin Diversification aren’t “beat the market” strategies…

They’re “risk-management” strategies… aka “defend yourself from ignorance and surprise” strategies…

Aka “don’t blow your portfolio up being an idiot” strategies.

You want to have an Asset Allocation plan in place for one simple reason…

Sometimes stocks go down.

Or… to say something less controversial and brave: Every few years or so, the assets that perform well and the assets that perform poorly… change.

After the tech bubble crash, from about January 2000 to July 2002, the asset to buy was gold. 

During and after the financial crisis, from about December 2008 to December 2012, you wanted to plow money into passive index funds like the Nasdaq and S&P 500.

And so on.

The word for this in fancy dancy financial speak is “rotation.”

Rotation happens across sectors and assets because institutional and retail money tends to go where it thinks it will earn the best return. 

Ideally, what you want to do is anticipate this rotation not by chasing trends… but by owning a little bit of everything already, before the rotation begins…

And then putting a bit more of your money toward the assets that seem like they have the most long-term potential in that moment. 

I’m suggesting this to you because I know enough people who went broke chasing fads and short-term trends, throwing all their money at the NEXT HOT THING, like tech stocks or forex or commodity futures or daytrading.

I’ve seen the horrible things that happen to their life afterward. 

To put that another way…

I would rather not get “market-beating returns” if it meant that I had safely minimized the chance of ever losing all my money.

Because being poor sucks. It really sucks. 

So to ensure the line of your wealth keeps trending up over time, what I want you to do is think about your asset allocation strategy as being like a mixing board:

Each of those “faders” controls the volume of one element of a recording. 

Depending on what’s happening in a song, you might want to raise the volume of one set of instruments and lower the volume of others.

A good Asset Allocation strategy will do the same thing…

Some years you’ll want to “raise the volume on” (put more money toward) passive stock index funds…

Some years you might want to put more money toward gold, commodities, real estate, collectibles, bonds, options…

Or, more simply, some years you might want to move money from passive stock indexes and go looking for individual stocks.

A lot of this decision-making process–choosing what to invest in–depends on:

• How diversified you want to be

• How much risk you’re willing to take

• What’s going on in the economy

• How much money you have

• How much time you want to spend managing your investments

• How old you are

To get clarity on the first three, I wanted a simple indicator…

Something that cut out the noise of the news and the hundreds of econometric measures on which I could base investing decisions. 

Essentially, I wanted to know the “danger level” of the stock market…

So I could ramp up my stock investments when danger seemed relatively low and ease off when danger seemed high.

So I began researching what would become the MAC Indicator.

Let me tell you how it happened…

A STORY IN WHICH: Sean Spends Two Years Correlating Economic Indicators

Actually… No. 

I’m going to spare you the details of how I built what is, in effect, a very large spreadsheet:

You don’t need to know how this looks at everything from the Federal Reserve Bank balance sheet to how many auto loan defaults there were…

You don’t need to know how it normalizes over 24,000 data points using z-scores and weighted averages…

You don’t need to know how it incorporates Bayes’ Theorem or the Kelly Criterion…

I’m falling asleep just thinking about it all. 

That’ll all be on its own landing page on diywealth.com some day. 

For now, let me just explain what the indicator actually… uh, indicates? I guess? In really really simple terms?

A CHART IN WHICH: Stocks Do Bad Bad No Good When The MAC Goes Up

Ok look at the chart below and let me try to explain what’s going on here…

The orange line is my MAC Indicator. 

The blue line is how good the S&P 500’s returns (inflation adjusted and averaged annually) have been since that date. 

When the MAC is at 0 on the chart it means: average. Humdrum. All signs pointing to normal, Captain.

Same goes for the S&P 500: a reading of 0 on the chart means the S&P 500 delivered its inflation-adjusted annualized average total return (about 16.1%).

A higher reading means returns were higher than average, a lower reading means the return was lower than average. 

So to interpret the chart for you:

When the MAC gets high, stock returns get bad.

When the MAC gets low… buy buy buy. 

And when the MAC goes above 0.5? 

A market crash will begin sometime within the next 6 to 18 months.

Seriously. You can see, on the chart, how an elevated MAC reading accurately predicted the tech bubble collapse, the crash during the Great Recession, the Pandemic Panic or Coronavirus Crash, and the current market correction we’re seeing right now. 

THIS is the big reason why, in recent posts, I was saying things like, “Don’t go all in on stocks just yet” and “We might see a few years of sub-par returns from stock indexes.”

It’s because the MAC tells us whether conditions are good for stocks to perform well…

Whether we should be more “risk on” or more “risk off”...

And also when and whether we want to be making concentrated bets in the markets. 

For the last 8 months? 

The MAC has been giving us some clear answers to our Asset Allocation questions:

• How diversified you want to be: “Very”

• How much risk you’re willing to take: “Little”

• What’s going on in the economy: “Bad stuff.”

When I first saw what the MAC was saying I should do…

I listened. 

So the recent downturn and correction that has been happening in the market for the past few months…

It didn’t really affect me or my money.

I had already mostly rotated out of passive indexes (and set trailing stops on my other positions) when the MAC signaled danger ahead.

And based on its current reading, it doesn’t look like we’re out of danger just yet. 

If I were more of an arrogant firebrand, I’d probably get a lot more attention and readers by saying things like “Get out of stocks now!” or “Go all-in on Beanie Babies!”

But like life, investing isn’t an all-or-nothing, 0 or 1 proposition. Nor is it ever perfectly certain, no matter how much data you have.

So if you’re looking to invest… keep a big wad of cash handy. 

Your best bet is probably in individual stocks for the long term, or active funds…

Or just other non-stock assets. 

What assets should those be?

I’ll get into that next week.