Trend following as a diversifier

Key Markets report for Monday, 1 April 2025

So far, 2025 started badly for US equity markets with S&P 500 losing 6.82% through 31 March and Nasdaq 100 dropping 10.42%. As it happens, as soon as the markets haven’t made new all-time highs for a few days, some investors get nervous, wondering if the bubble is about to pop. Every little correction triggers at least a few prominent market experts to predict that “this is the one,” we’re heading into a collapse, it’ll make 1929 look like a walk in the park, etc.

Forecasting is a waste of time

In the recent past I’ve mentioned a few of these, like Jeremy Grantham who started warning about the coming market collapse already in June 2020 and grew increasingly shrill as the S&P 500 continued to defy his predictions. In January 2021, wrote that that "Bursting Of This "Great, Epic Bubble" Will Be "Most Important Investing Event Of Your Lives," and followed up with warnings of a "Spectacular" Crash In "The Next Few Months." Then there was John Hussman who called for a 64% correction in the S&P 500 in July 2023. Last December, Henrik Zeberg (The Zeberg Report) predicted a 50% decline (or worse) for this year.

Eventually, a handful of these analysts will turn out to be correct when the bubble really does pop, and then they’ll be celebrated as the geniuses who predicted the 20XX market crash! Does anyone still remember Nouriel Roubini, the rock-star economist who predicted the 2008 financial crisis? He predicted another few crashes since then, until his star eventually faded. What about the great investing legend Benjamin Graham? Here’s a chart with two of his predictions from “The Intelligent Investor”:

I could go on, but the point, and the basic tenet of our approach to portfolio management, is that prediction, no matter how sophisticated, doesn’t work. As such, it isn’t a reliable means of decision support for investors. Benjamin Graham’s career overlapped with an (until then) unprecedented trend in equity prices and he and his partner Jerome Newman made one lucky investment that made them into legends we recognize until today: Geico.

A lucky strike

Graham and Newman ploughed fully a quarter of their fund’s assets into Geico, purchasing 50% of its shares. They held onto that investment even though it was overpriced, by their own value investing standards, from the day they bought it. Geico alone accounted for well over half of their fund’s performance although it wasn’t a “value pick.” It was a momentum investment which earned them huge windfalls from the trend that carried Geico’s valuation from overpriced to way, way, way overpriced.

Thanks to trend following, which they did inadvertently, they didn’t have to worry about making any predictions about the markets, since they were obviously no better at it than Hussman or Grantham. They also didn’t have to worry about Geico’s valuation - they weren’t too good at that either: on balance, all their value picks were losers. Value investing would have made them underperformers as investment managers. If not for Geico, nobody today would even know who Benjamin Graham was. This may seem like sacrilege, but it is true. Read all about it here: “Why trend following beats value investing.”

A diversifier, exactly when investors need it most!

But even if we don’t stumble on a lucky Geico, Tesla, Nvidia or Bitcoin, trend following offers great value to investors in another way: diversification. This morning I ran a quick update of our Major Markets portfolio which is a mini-version of a typical diversified trend-following portfolio (trend followers typically run portfolios which include 50 or more different markets; Major Markets includes 16). Here’s its performance since the start in January 2020:

The portfolio has been in a drawdown since late 2022, an unusually long time, but in spite of that its overall performance is unmistakably showing inverse correlation with the S&P 500, exactly in periods when the the stock markets go into significant corrections or reversals (areas marked by red dashed rectangles).

So far this year, Major Markets is down 2.71% - not yet positive, but significantly better than the S&P or Nasdaq. If it turns out that Zeberg is right and the current correction turns into a proper bear market, we can expect that trend following strategies will all switch to the short side and generate gains from market decline. Thus far, our exposure to S&P 500 is still net long, but on Nasdaq and Russell 2000 we've already switched to net short.

In all, trend following tends to work over the long haul. It provides a much more reliable means of decision support for investors as it does not entail prediction or asset valuation, but simply a disciplined adherence to tried and tested rules of trend following. It also offers an important way to diversify investment portfolios so that when, not if, we experience a proper market crash, investors may profit from it instead of getting crushed.

To learn more about TrendCompass reports please check our main TrendCompass web page. We encourage you to also have a read through our TrendCompass User Manual page. For U.S. investors: an investable, fully managed portfolio based on I-System TrendFollowing is available from our partner advisory (more about it here).

Trading signals for Key Markets, 1 April 2025

With yesterday’s closing prices we have the following changes: