The stocks that I sold were the ones that would be most affected by a recession in Australia - entertainment stocks, retailers, one steel maker and a construction company - so it may be just as well to off-load them now. Of course, it would have been much, much better to liquidate my Leveraged Equities account back in 2007 when I was seriously thinking about reducing my margin lending accounts and investing via my SMSF instead.
Overall, my 20-year experiment with gearing has been a disaster. As happened last time (in the 90s), the use of gearing has meant that I am unable to buy into the market at the bottom (indeed, I'm again being forced to sell stocks when the market is down). I had thought that this time around my gearing was reasonably conservative (only using 50%-60% LVR, rather than the maximum 80% as the market rose), but the 2008-9 bear market has exceeded my "worst case" scenarios of the usual 20%-40% drop during a bear market. When the market does eventually start to rise again, I won't be maintaining the current 90%+ LVR levels by increasing my borrowings, so even if the market regained it's previous peak my equity wouldn't fully recover.
The scope of my stock losses during the 'Great Recession' shows that my strategy of keeping gearing levels at around 60% LVR during bull markets and then simply holding on and riding out a "typical" 20%-30% bear market was flawed. It didn't have a contingency for a severe recession (well, it did in the form of my Index Put options, but letting them expire in Dec 07 negated that strategy). So I'm working on a revised strategy that will employ dynamic asset allocation to reduce my gearing levels during future bear markets. The trick is to get the timing of such reallocations correct. Many pundits say that 'timing the market' is impossible (assuming random walk/efficient market theory holds), and that examples of successful timing can be attributed to luck.
A book I read a few years ago suggested selling off stocks that had broken their up-trends and dropped by 10%, thereby limiting losses during bear markets, could produce superior returns to simple 'buy and hold' strategy. I'm trying to adapt that theory to help avoid losing too much in any future severe bear markets. My current model is to sell off my geared stock portfolio when the 60-day moving average closing price falls more than 10% below the high attained since the last 'buy' signal. The 'buy' signal (to initially invest, or to reinvest after exiting the market) would arise when the market index daily close had risen 10% above the low reached since the previous 'sell' signal, and stayed there for at least 5 consecutive days. So far back-testing with daily data for the All Ords since 1984 suggests that using these signals to time strategic asset reallocations would have moved you out of the market relatively early in a bear market phase (and without too many false sell signals), and got you back into the market when it had bottomed out. The model did fail with the current 'Great Recession', as it signalled a 'buy' in May 2008 (when the market appeared to have bottomed out), only to signal another 'sell' in June after the market had continued to slide. But mostly using the model to time exits and reentries into the market would have restricted losses during bear markets to around 20%, which would have produced superior returns to 'buy and hold' in about 75% of bear markets. Overall it would have improved my ROI considerably since I started investing in stocks in the early 80s. I could tweak the parameters of this model to eliminate the false 'sell' signal in 2008, but optimising for historic data doesn't mean the model would perform any better in future periods. Keeping models as simple as possible, and retaining some common sense justification for what the parameters are, is usually more likely to result in a reliable model.
If the market doesn't drop too much further I'll retain my remaining current direct stock investments, and aim to slowly pay off my margin loan balances over time. I'll also keep our future superannuation contributions sitting in cash until 'the model' gives a buy signal - currently that would be the All Ords Index closing above 3422 for five days in a row. I may then start to use some leverage within our Self-Managed Superannuation Fund investments - either via buying Comsec CFDs for the market index (if there's a suitable CFD available), or else by investing in a geared stock fund such as the one run by Colonial First State (providing the fees aren't too high). Otherwise I'll just start moving the accumulated cash into the Vanguard High Growth Index Fund.
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