Don't Follow the Wall Street Crowd - Prepare for Market Rollover 12 comments
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Uh oh…
If you’re looking for what the “crowd” is thinking, you can’t do better than Barron’s “Big Money” surveys. In a nutshell, the survey illustrates what money managers as a whole are thinking about the markets. As you’d expect, betting against these guys is an extremely profitable exercise.
Back in late 2007/ early 2008, Barron’s surveyed 12 Wall Street strategists. Every one of them forecast that stocks would head higher in 2008. The forecasts ranged from an increase of 3% to 18%, with the group’s average forecast at 10%.
How’d that work out?
So it was with some concern that I noticed Barron’s latest “Big Money” survey revealed an overwhelming bullishness from money managers. All told, 62% of money managers surveyed thought stocks were undervalued. 70% said stocks would be the best performing assets in 2009.
To be blunt, I don’t know what these guys are smoking. The U.S. is entering the worst recession in 20+ years. The Feds are cooking up an inflationary storm of epic proportions. In the meantime, financial markets are experiencing their first taste of real deflation since the Great Depression. And the financial crisis still hasn’t been fixed.
This last point is key. The Federal Reserve’s moves have established the Fed as the backstop for every debt market imaginable (including non-secured commercial paper)… but you cannot fix a debt problem by issuing more debt.
Bernanke spent his entire academic life studying the Great Depression and doesn’t see the difference between that crisis and this one: that was a liquidity crisis THIS is a solvency crisis. Speaking of which…history is decidedly against a sustained rally or the renewal of a bull market in stocks too.
The market has experienced four October crisis in the last 100 years: 1907, 1929, 1987, and 1997. Following each of these, the market staged a sharp, short-term rally (much like last week’s) before rolling over to either test its recent lows…or break down to new lows entirely. Again, every time an October crisis ended, there was a short, sharp rally followed by stocks rolling over to test or break through the Crises’ lows.
Most importantly, the two times that the market only retested its lows - 1987 and 1997 - the U.S. economy was strong. In contrast, the two times that the market broke through its lows - 1907 and 1929 - the U.S. was in a recession… just like today.
click to enlarge
As you can see in the above chart taken from the October crisis of 1987, stocks rallied strongly in late October, before beginning a slide back to re-test their lows in early December. But remember, this was at a time when the U.S. economy was strengthening, not contracting like today.
Combining all of these elements - rampant bullishness from money managers with ever-worsening fundamentals AND worsening economic conditions - I believe the odds are that stocks will roll over sometime in November. I wouldn’t be surprised to see new lows in the S&P 500. We certainly should at least see the market re-test its October lows.
However, I must stress that the U.S. Government’s current nationalization/ interventions are unprecedented. Put another way, there is no historic U.S. precedent for analyzing what is occurring in the financial markets. Because of this, pinpointing exactly what will happen is impossible. History gives us a rough road map, but the roads today are different than before. But the important thing to note is that fundamentals - both on a financial and economic scale - are worsening. And this increases the likelihood of historic developments - the market rolling over in November - coming to fruition.
I suggest you prepare accordingly.
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low RE land and construction costs. The stock market today has lost tremendous support and after playing ping pong day trading, I decided that I'm on indefinite hold until fundamentals improve...perhaps 2 years from now!!!! MarvinMBA
It is not about optimism/ pessimism, it is about accepting the pessimis and looking forward deciding what it is going to be, - inflation or deflation.
And don't tell me there aren't undervalued stocks. There are many trading at 5 P/E, where normal for them is 10P/E, and this is already on earnings adjusted downward.
You need to look a bit ahead, - may be 6 months from now,not what is happening today, to come up with a workable strategy.
However, most analyst are so used to their "toolbox", such as quant analysis and sentiment indicators, that they fail to see forest behind the trees.
www.ers.usda.gov/publi...
Of course, there have been so many other changes in so many dimensions in the US since then that any comparison with 1930 is almost irrelevant for policy purposes.
All their training, analysis and techniques (P/E ratios, buy and hold, buy on high VIX, invest for the long term, etc) are based in a life of "wisdom" based on a systemic bull market. They cannot change easily their mindset to live a different paradigm.
The bear is here to stay for many years, maybe a decade.
Throw away all your previous training and wisdom and re-learn your lessons, based on the assumption that this time things will not be fixed "magically" by the FED or the Gov. Short with no remorse until the country fundamentals are back on track again.
We hear and see so much in the media devoted to whether the markets have found a bottom and where the bottom might be, but the truth is no one knows. Prediction is little but speculation and has no value. In his excellent recent book, Beat the Market, Charles Kirkpatrick quotes commentator and chief market strategist Barry Ritholtz as saying the SEC should require all analyst and pundit forecasts to publish the following caveat: "The undersigned states that he has no idea what's going to happen in the future, and hereby declares that this prediction is merely a wildly unsupported speculation."
As Mr. Kirkpatrick notes in referring to David Dreman's research which studied 78,695 earnings forecasts by analysts over a 20 year period from 1973 to 1993 only 1 in 170 forecasts were within 5% of any four consecutive quarter's actual earnings. Why do we continue to rely on such speculation?
jegan ;-)
It is a deflation and spreads have already widened. So you should be putting money in long term corporate bonds, and a few other similar asset classes. The principle. Then as the coupons come in, use them to average in to common stock positions, to exploit the low prices on offer. Gradually, there is no great rush.
Finance corporates can be bought today with 10 to 30 year terms and double digits rates. Diversify by also having a 10-20% position in TIPS (yielding over 3% plus inflation adjustment), likewise in GMNAs (6%, both with no credit risk), and in floating rate bonds or preferreds (those can be bought today to yield 8% and up, and will return double short rates forever if they remain solvant). Keep a moderate position in insured CDs but don't hoard there.
The name of the game is simply to lend money when no one else will. Pick the credits, and go long on the terms, because spreads will tighten once this passes. Avoid "core" bond funds that right now will be stuffed full of short term treasuries bought by timid managers trying to get slightly less killed than the index.
If you are adventuresome, you can include small positions in loan participation funds, junk bond funds, and equity REITs or REIT funds, and distressed mortgage debt. All of which could get killed, still, so these are 5% positions at most. Only even look at them if you see 15-20% yields on offer - it will take half that figure to cover the loan losses.
Now, when you get coupons from all of the above, invest them in distressed equities. You don't want to be defensive, don't go looking for short term trades or try to hide in consumer non-cyclicals and health care etc. Let the mutual fund manager herd do all that. Instead buy financials, buy real estate related names, buy materials, buy retailers, the stuff smashed to heck and gone. Just don't invest any principal in them. Only your interest!
This will average you in to a 50-50 stock vs. bond position on the right 5 year time scale. Don't worry about inflation. One, there isn't going to be any for a short spell. Two, if there is, it will cause spreads to recover, your first stock purchases likewise. And three, because your TIPS and floating rate positions will benefit. Four, because you own a house (you do own a house, right?), and that is all the inflation bet exposure you require.
This is one of the best investing climates you will see in your lifetime. But that doesn't mean gun risk and jump in frantically, expecting it all to go straight up starting tomorrow. It won't, and you don't need it to, or even want it to, really. The longer prices stay cheap, the more stock you can buy with someone else's money (interest received, not borrowings).
I hope this helps.
S&P500 will therefore trade between 388-754 soon enough based on a PE of 8.
Face reality.