A reader noted that I felt a huge rally, really huge, would come but I should note that it came a little over two months after I would have thought and has exceeded any duration I would have thought reasonable. Going up 40-50% is not necessarily shocking only because it has happened before in short violent spurts but in another week the rally (or bull market) will be five months old which seems like a long time for this sort of whatever it is.
For months I felt there would be a big rally (mostly because big feel good rallies occur regularly in scary events) followed by one more scare-the-hell-out-of-them decline. When the SPX was at 900 I probably thought down to 700 would scare some folks. From here maybe 800 would do it. I don't recall trying to guess where it would go down to so much as hope clients would realize what could be in store and thus not panic if it happens. Mental preparation for a big decline is a good way to avoid panic selling.
While I have not changed my mind the scenario could turn out to be wrong. In getting defensive in the portfolio (still am defensive but less so than a year ago) I said I would hope to go down less but that the trade off would be to go up less on the snapback. This of course is another way of saying I'm less volatile than the market which during the bear phase which is not a bad idea.
Personally the last couple of months have been more difficult to figure than most parts of the current cycle. I still have cash and a small double short position. One idea for moving in to equities can be to swap holdings that might be less volatile for ones that might be more volatile keeping the same cash level. So for example someone owning Exxon Mobil (XOM) could sell that to buy something like Murphy Oil (MUR). I don't own either name it is just an example.
That type of swap does a couple of things. XOM has a market cap of $340 billion, Murphy is $11 billion. The average cap size of your portfolio comes down quite a bit, smaller historically does better for most of the cycle starting early on. It only takes a couple of swaps like that to bring the portfolio's market cap way down. The XOM for MUR swap also juices up the beta a little. Yahoo Finance has XOM's beta at 0.41 and MUR at 1.02. I won't vouch for those numbers but if correct then you increase the overall beta a little. If that is not enough juice you could go with Weatherford International (WFT) which has about the same market cap as MUR and a beta of 1.78. WFT is also a name I do not own, this is just an example.
Another type of example along these lines is to swap a narrow ETF for a stock. Typically a stock is more volatile than a related ETF, I say typically.
Hopefully it is clear that if the volatility of the portfolio is increased while keeping the same cash then the portfolio will likely track closer to the market in both directions.
One other point to make is about psychology. There was a period there where a lot of people were convinced that we were going to have a depression as bad if not worse than the one in the 1930s. Not just the financial system was in jeopardy but the American way of day to day living was in for some serious trouble. I tried to convey that it was not as bad as that. Clearly a lot of the details causing the event were different but as I pointed out then and will point out in the next scary event the most extreme outcome is a low probability. People tend to bring more fear than is actually warranted. I'm not saying this hasn't been plenty bad because it has but I would not describe the outcome as a complete tearing of the social fabric.
In that same vein I believe a lot of people are bringing too much faith that it can be over so quickly. Jobs don't appear to be on the path of going positive anytime soon, GDP estimates for when they turn positive appear to be below a level that provides job growth, current equity prices appear to be well ahead of what revenue will be in the next few quarters and if you were afraid of deflation or inflation six months ago I doubt you've changed you're opinion. While things were not as bad as some feared they were/are bad and so believing things are now all better seems unrealistic.
I feel that being in (with some defense) lets you capture at least some of the move up no matter how high it goes. And obviously a moderately effective defense should mean you go down less if a decline starts tomorrow. Being right or should not be the priority. The priority should be reducing the consequence of being wrong.
I did not take that picture. I believe it was in the WSJ quite a few months back.
14 comments:
Roger,
here we have the mentality that if we go down 10%, we go up 20%. That does not work forver. One thought about numeraligy. 666 + 333 = 999. That is our S&P. My numbers still point to higher numbers and there seems to be a rotaion of stocks. How far more we will go - no one knows. I'll be taking a coutious position. I have sayed that we may go up til late 2009 and then go down til 2011. I still feel that way, but the go up part with caution. Bill Gross has a great outlook for august 2009. His argument is that the world is not the same and growth has changed since 2007. Putting that into prospective can we go up to 1300 on the S&P. Very unlikely. 1050 1150 is a possibility. However I rather pass up the 100 S&P point and concentrate on the S&P 700.
I will be on the beach with family and kids.
Best,
Jeff from Milan, Italy
Jeff have a fun time and a safe trip
Maybe the market is going up because the fundamentals justify it. During the last couple of weeks there have been many stories in WSJ about earnings beating expectations and you are starting to see a couple of companies raise dividends.
All this negativity makes me feel like my 10% cash is way to cautious. Not only do I think 1050 or 1150 are possible, but 1350 may be possible. I do not know but am unwilling to take any projection off the table. I guess I am finding wisdom in Gartner's view that just getting the trend right is sufficient.
I am beginning to believe the market may go higher and longer than any of us expect. The market could just grind higher as we all eventually give up and buy into this cyclical Bull market cycle.
Great post, Roger!
Just one thing; you say "if you were afraid of deflation or inflation six months ago I doubt you've changed you're opinion"
I have changed my opinion, sort of. Before I was afraid of both, but now I think only INflation is the bogeyman under the bed. This change of heart is because I had a really good think about what happened to Japan and consider the risk of this outcome in the west to be close enough to zero to not warrant further thought/protection.
The inflation I think we'll see will be a continuance of the massive inflation of the last 8 years or so - gold quadrupling, oil going up by up to 700%, generally almost all commodities rising at unsustainable rates. Yes, the recent deflation has been a setback for commodities bulls but in seeing the massive amounts of worldwide stimulus making up for private investment in this recession, I cannot see serious deflation within the next economic cycle.
After then, well I think it'll be up to the emerging markets' leaders to convince their new middle classes to spend like it's going out of fashion. A bit like we've been doing for the last 20 years.
So how/why did consumerism replace old-fashioned values in so many in the west? Was the mindset created in the 80s, via changes to policy, taxation and the belief in the theory that 'greed is good'? And if so, can that be repeated in the east with their own greed is good moment ?
If it can be (and I'm massively stretching here), we could be in for a repeat of the roaring twenties. If that is the case the argument for long-term investing in equities is overwhelming. Regardless of whether we have another leg down if your horizon stretches for 10+ years then you will benefit from globalization. As it is, producing and consuming nations alike are already benefiting, and you can't put that genie back in the bottle.
" I still have cash and a small double short position"
So are you >50% or <50% long?
Personally I think the bear market ended in March but we've deviated from the intermediate term mean. My guess is we'll see the market trade between 1000 and 850 for the next couple months, but won't take out the March bottom anytime this year.
Employment is a lagging indicator, inventories are up, consumer demand will increase, and the Government has pumped a lot of money into the system.
That said, the prospects for normal, post recession growth are weak. Huge deficits and reluctance to participate in our bond auctions is going to push upward pressure on interest rates and taxes - not to mention increased regulation and government mandates.
I don't see how that translates into big moves in equities in either direction.
To prosper in the next 2-3 years is going to require good intermediate term timing and/or good stock selection. My guess.
Hi Tom, never got close to less than 50% long. at my most defensive maybe 65-70% long but that was not for a very long time. close to 80% long these days is probably about right for most clients these days but the volatility of the holdings is on the low side.
"Prediction is very difficult, especially about the future."
(love this quote but since I've seen variations credited to everyone from Yogi Berra to Confucius I treat the source as indeterminate; e.g., I know Niels Bohr once said it too).
Whether we are climbing the proverbial wall of worry into a new cyclical bull or headed towards another down-leg after a bear rally, a defensively long strategy combined with rebalancing based on pre-established criteria seems entirely appropriate IMHO. I might think differently if I were aware of more macroeconomic indicators supporting a strong recovery hypothesis but at this point I don't see enough to even lower the unemployment rate and I frankly regard that as crucial (note that unemployment rate is considered a lagging indicator in classic business cycle theory but in contemporary macroeconomics it is considered coincident or leading; e.g., http://tinyurl.com/koj3qh and http://tinyurl.com/nofmh8).
To be honest I see little evidence things are significantly different globally and/or longer term either. For example, improvement in tech is consistent with a cyclical recovery, even a weak one, but improvement in commodity prices is not and, to the degree we are seeing any of that, it seems more likely a revival of the Yen/Dollar/Renminbi carry trade and/or hoarding; the former is speculative, the latter implies preparation for financial trouble, neither explanation is favorable.
Shorter me: I remain skeptical that recovery will be sufficient to sustain this market advance or, for that matter, that the inflation/deflation/range-bound debate is settled but will be delighted to be proven wrong; a return to some degree of normalcy on all fronts would be most welcome.
We have a political environment the likes which has not been experienced in this country before - not even through the first eight years of the FDR administration.
When the gameplan is redistribution of wealth and the population influx and the urban areas reflecting third-world behavior, it may give individuals pause before going "all in" for the long term in domestic securities.
Anon 1:29,
Interesting comment. I agree that something "feels different" now socially. Can't quite put my finger on it, but I feel as a small businessman I am being punished for trying to build wealth. I honestly believe a good portion of our society is ignorant regarding wealth creation and its impact on them. That said, I still think the USA is the greatest country on earth!
I think Gross is confused with the impact on his industry - caused by the new regulation coming down from government - with thinking every industry is going to have its business hamstrung by Washington.
The markets recapture close to 50% of its losses in just under five months...this is what happened in 1930 - and in 2009. What scares me is this is the same mood that took over the markets in early 1930. There is a general belief that the 29 crash burned the individual investor while the drop after the 1930 rally got the institutions and professional traders. With this rally having such light volume due to the individual investor sitting in cash, it seems this could be a correlating situation.
The underlying causes of the recession still exists. We still have excessive debt to GDP and a credit contraction. The banks still have massive amounts of toxic assets on their book. They just don't have to price to market. The Fed has essentially attempted to stabilize the economy by performing the very activity that started all this malinvestment. Not sure if we can fix a problem by performing the very actions that led to the problem.
I don't think we will eventually lose 89% like the Great Depression, but I find it hard to believe we are through this mess. The underlying problems associate more with the problems from the 30s than the 70s, 80s, and 90s. If emotion turns negative from the current bullish mode, it could be a hard drop. So building a more defensive posture right now is probably the safe action.
If the administration came out with a detailed plan to reduce the deficit, we might have an enormous bull market. Is anybody in power listening?
Interesting juxtapositon of comments here at the end: A detailed plan to cut the deficit is exactly what they did in 1930; the plan was implemented too ...
it took seven years to even partially recover from that but things did look better until FDR lost his nerve and, reversing course, tried to cut the deficit in 1937 ...
took another seven years and WW II to come back from that one.
There's a lesson in there somewhere one suspects: Possibly deficit cutting is not what you want a government to do when no one else is buying anything or something like that.
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