By definition, cannibalizing describes an act where a person’s attempt to improve a condition backfires against an existing situation. Not willingly, nevertheless very effectively, investors have been cannibalizing their own portfolios.

Enticed by a multi-decade bull market, many investors tried to improve their portfolio’s return. Based on the almighty wisdom of the risk/reward principle, we know that high returns and a high degree of safety cannot co-exist.

Even though it has been thought that portfolios can be milked for extra return without giving up safety, deep down we know that one has to be sacrificed for the other. Many opted to cannibalize safety for higher returns and got neither.

A quick glance at a chart reveals that the Dow Jones (NYSEArca: DIA), S&P 500 (NYSEArca: SPY), Nasdaq (Nasdaq: QQQQ) and many other indexes trade at levels not seen for well over a decade. When it comes to investing, time is money and the last decade has been a “lost decade.”

The “lost decade”

Lost, why? $100,000 invested in the S&P 500 from April 1989 to April 1999 would have mushroomed into $426,000. $100,000 invested in the S&P 500 from April 1999 to April 2009 would have shrunk to less than $65,000. $100,000 invested held from 1989 all the way to 2009 would be worth $284,000 today. This translates into a 20-year average annual return of 5.3% before taxes and inflation.

What effect did inflation have over the past 20 years? In 1989, you could get a first class stamp for 25 cents, a gallon of gas for $1.12 and a dozen of eggs for 96 cents. The median household income was $29,000 and the average home cost less than $149,000.

Taking into account taxes and inflation, the last two decades are just shy of being a complete washout. The stock market has fallen way short of delivering the types of returns needed to accumulate the proverbial golden nestegg.

Lessons No. 1: Buy-and hold investing is dead

About once every lifetime, eras with the propensity to render decade old investment patterns worthless come along. 2007 marked the onset of such an era.

When the bear market arrived, it took no prisoners. Buy-and hold investing along with diversification are not the only but some of the most popular bear market casualties.

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An equal weighted mix of the Vanguard Total Stock Market ETF (NYSEArca: VTI), iShares Barclays Aggregate Bond ETF (NYSEArca: AGG), iShares Dow Jones US Real Estate ETF (NYSEArca: IYR), iShares MSCI EAFE (NYSEArca: EFA), iShares MSCI Emerging Markets ETF (NYSEArca: EEM) and the iShares S&P GSCI Commodity ETF (NYSEArca: GSG) would have lost 48.12% from the market peak (October 9th, 2007) to the March 9th, 2009 lows.

As a point of reference, the S&P 500 lost 55.19% over the same period of time. Would you prefer a 48% loss or a 55% loss? I’d prefer to pass on both.

Unless a diversified portfolio was disproportionally weighted in either bonds or gold, the results were quite similar. The SPDR Gold Shares (NYSEArca: GLD) gained 23.91%, yet the broad iShares S&P GSCI Commodity ETF (NYSEArca: GSG), which sports a 10% allocation to gold, lost 47.20%.

Here’s what veteran investor Jim Rogers thinks about diversification: "Diversification is something that stock brokers came up with to protect themselves, so they wouldn't get sued for making bad investment choices for clients. Henry Ford never diversified, Bill Gates didn't diversify. The way to get rich is to put your eggs in one basket, but watch that basket very carefully. And make sure you have the right basket. You can go broke diversifying. Ask anyone who's diversified in the last three years. They've lost money."

While I do not entirely agree with Jim Rogers, there is a lot of truth to what he says. For over a year now, ETFguide has been promoting a pro-active approach to investing (more about that later). Buy-and hold may have gotten you into a precarious situation but it won’t get you out.

Lesson No. 2: Be a trend-setter

Most investors - novices and pros alike - rely on news and news-based forecasts to make their buy/sell decisions. News is always good at the top and bad at the bottom. Excessively bullish news will trick you into the market before it falls, excessively bad news will squeeze you out of the market before it bounces. A consistent flow of good news reports will translate into extreme investor optimism and vice versa.

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This phenomenon has made the Volatility Index (VIX), also called the Fear Index, one of the more reliable proxies to determine the market’s direction. The ETF Profit Strategy Newsletter used extreme investor optimism to identify the January 2009 market top which was followed by a 2,700 point decline in the Dow.

It often pays to go against the trend, the more certain a trend seems to be, the higher the chances of a reversal. Take for example investor's enthusiasm when the Dow broke beyond 14,000 or the popularity of Toyota Prius' when a gallon of gas sold for nearly $5. Just recently, goldbug's seemingly certain bet on $1,500/oz gold was met with bitter disappointment (see related article: Gold ETFs - Is A 30% Drop Next?)

Lesson No. 3: Be where “the puck is going to be”

Earlier we talked about a pro-active approach to the market’s changing disposition. During a period of falling prices and long-term capital depreciation, it makes sense to capture gains wherever they can be found. As Wayne Gretzky put it, you have to be where the puck is going to be, not where it has been.

Of course, this was easy for Wayne, arguably the greatest hockey player ever to strike a puck. Discerning the future direction of stocks however, has been next to impossible, even (and especially) for the pros. In fact, the pros seem to have been the ones who threw caution to the wind and propelled the biggest equity bubble ever seen.

Private Equity Giant Blackstone Group for example, must have thought the bull market would go on indefinitely when they bought Hilton Hotels for $20 billion at the top of the market in 2007. Blackstone’s real estate portfolio declined some 30% since.

Unlike the investing masses who follow news-based analysis (which includes earnings and earnings forecasts), the ETF Profit Strategy Newsletter bases its forecast on a no non-sense common sense analysis. Based on this analysis, we outlined Dow 6,000 to Dow 6,700 as the bottom of the most recent bear market leg (the Dow bottomed at 6,440) which was to be followed by the largest rally since October 2007 (the market rallied as much as 32% since).



Early in January, the newsletter recommended short ETFs such as the UltraShort S&P 500 ETF (NYSEArca: SDS), UltraShort Financial ETF (NYSEArca: SKF) and UltraShort Real Estate ETF (NYSEArca: SRS). In a special Trend Change Alert on March 2nd, seven days before the market bottomed, we recommended to start selling short ETFs and move into long ETFs such as the Financial Select Sector SPDRs (NYSEArca: XLF), Ultra S&P Financial ProShares (NYSEArca: UYG) and many others. 

Does this mean you should rearrange your portfolio every few weeks and dump all your assets in short ETFs? Most certainly not. Just because you have a navigation system in your car, doesn’t mean you use it to get to the grocery store down the road.

Discerning the stock market’s long term (years) and mid-term trend (months) direction, however, will help you not to be caught on the wrong side and allows you to hedge against or benefit from further losses.

According to our analysis, this bear market will resume eventually. A detailed forecast with short, mid and long-term target levels and corresponding ETF profit strategies is available in the brand new issue of the ETF Profit Strategy Newsletter. It’s time to get your portfolio where the “puck’s going to be.”