The One Move You Must Prepare To Take - While Others Are Wringing Their Hands

by: Joseph L. Shaefer

By positioning our portfolios on the long side in the 4th quarter, we have enjoyed the fruits of this nice rally. What's likely to occur next?

In the "very short" term - the next 2 to 4 weeks, of little interest unless you are an active trader - I imagine we will see a great deal of churning about. We may break out to a new high or we may try but fail to do so. The most likely course is a slight pullback that allows the market to catch its breath. Then in the short term - through tax season or so - I see the market making up for any very short term decline but still getting nosebleed somewhere at what would be a triple top of 14,200 or so. It could chug higher but would likely be vulnerable to any ugly headlines from the US, Europe or the emerging markets.

If that occurs, we can expect one more ugly decline in the late spring and summer at which time I think this dying secular Bear will give it's final gasp. The first year or two of a president's term is given over to kitchen-sinking all kinds of bad news, the idea being that by making a clean sweep of the unattractive he or his party can look good (relatively speaking) in the 2 years of campaigning that lead to the next election.

When there is a house divided as there is now, the bad news tends to come mostly in the first year; by January 2014 his party has mid-term elections to contend with. If the news isn't (again, relative to the previous year) relatively spiffy by the end of winter, the campaign is half lost. That's why I see the public once again reading about US gridlock, rising interest rates, stubbornly high unemployment, federal health care cost overruns, sequestration, potential rating downgrades, et al, later this year.

The politicians stopped preening in January and the markets rallied nicely. One does not aspire to be a politician, however, to get things done quietly. They love the sound of their own voice and will once again be murking up the water with their vitriol. I think this will spook both institutional traders, who will want to nail down their profits to ensure a good bonus, and individual investors who will want to protect their gains to, well, protect their gains.

Yet this activity will take place against a very different backdrop than that which we have seen over this long (2000-???) secular Bear. It will come at a time when corporations are preparing for, and real corporate earnings are giving early indications of, a surge that will ultimately overcome all the "negative" news, much of which will really be shown to have been full of sound and fury, signifying nothing.

US corporations, and quality global firms as well, as they become at the end of every serious economic contraction, are lean and mean and ready to engage in serious capital expenditures, tech upgrading and serious marketing. This, along with a huge reduction in houses for sale at fire-sale prices, and at least a private sector that is prepared to act responsibly in hiring and spending, will be the "story not told" as the bad news once again hits the front pages of our newspapers and financial websites. So underneath all the bad news from and unresponsive and irresponsible government, once again, still waters running deep - will be responsible and responsive companies doing their best by their shareholders and U.S. consumers, once burned, twice shy, making smarter decisions about their own personal finances.

Could I be wrong? Of course. This year may instead mark the beginning of the next secular bull. I don't plan to sell any of our core positions based upon my read of the macroeconomic and geopolitical environment just yet. But our "core" positions are long/short mutual funds and ETFs with a healthy dollop of steady income from balanced funds and non-US, mostly Asian and emerging market, income ETFs. Those we'll keep. We may enter a few tight trailing stops on our more market-trending positions which, if I'm correct and the market chugs higher, we will change to somewhat looser trailing stops.

I hope I'm wrong about the large decline in the middle of this year. I like nothing better than being right and profitable, unless it is being wrong and profitable.

But if I'm right, our decision to invest in core holdings that are not as market sensitive while deploying the rest of our capital at near 100% during the short term, will once more prove to have been the prudent thing to do. Our goal is always to participate well on the upside, albeit not as well as if we had thrown all caution to the winds and are hanging on for dear life as the train leaves the station. But when most investors give back all their hard-earned, or lucky, gains in the next decline, our core holdings in long/short, equity-income, and non-US fixed income, we are continuing to protect those gains. I'd always rather make 7% and keep it than make 10% only to lose 80% of it (8%) in the following cycle.

Speaking of cycles, that brings us straight to how we are positioning our portfolios right now. It takes a bit of patient forbearance not to rush in and buy double-long ETNs when we see the market roaring ahead to (possibly) new highs. And it will take great courage to buy in anticipation of the beginnings of the next secular Bull when the news is droll to dreadful and when others all around us are selling this summer and early fall. So we will do what we have done previously, in 1982 and 1983, when the last big secular Bear was winding down: we'll buy for both growth and safety. That means we are happy to give up a percent or two of "performance" when the flood tide is raging; we've been around long enough to know those who do so typically lose it all when the ebb tide pulls it back out.

When I think things will get better, but want to be prepared if they don't, I want the most stable platforms to hold in those tempestuous times. I look for certain characteristics in our investments. Right now, for instance, I am quite happy to build the model portfolios I recommend for your due diligence, comprised of a number of fine ETFs and companies that are participating fully in the market moves, but keeping a goodly position in our core long/short, balanced and income holdings.

I do like what I see in the short-term news. After all, capital spending rose nicely in the 4th quarter, and companies are flush with cash to continue that advance. Spending has been held back for too long on new software and productivity technologies, so I imagine that will provide yet another impetus to the economy in a key sector. Inventory levels are now low so any new consumer demand means manufacturing will gain even further this quarter and possibly next.

Consumers, too, are loosening their purse strings a bit, not getting crazy and going into debt, but buying the things they wisely held off purchasing during more difficult times. Durable goods in particular are picking up, partly because people are driving 11-year-old cars with 11-year-old safety features and partly because they need appliances and furnishings and such for those new households they are forming. I've been saying since 2008 that credit expansion and frothy housing prices got us into this mess; household credit contraction and home-buying at more realistic prices must be part of the equation to get us out.

We'll take advantage in a limited way of what I expect to see in the very short term (a natural pullback to digest the gains of November, December and January) by initiating some trailing stops on our very profitable previous recommendations. The harder task will be making the case for tighter and tighter stops in the spring when most people will have been convinced that Happy Days are Here Again. They may be - but we'll let our trailing stops decide that for us…

And the even more difficult task will be to convince investors to re-enter the market and try to stay put once the next upsurge begins, my guess being that will occur before the end of this year. This Bear is old and grumpy, but there is a new Bull just around the corner. It will of course arrive just when most are convinced we are headed for 6000 on the Dow again!

If the market pulls back over the next couple weeks, we'll be buyers of XOM at 83, RDS-B at 65, BP at 39, TOT at 44, STO at 24, JPM-WT at 10, WFC-WT at 9, BCS at 16, KYE at 26 and STWD at 24.

If I believe that the party in power will kitchen sink all kinds of bad news in the first two years after they are elected, what makes me so confident we'll see the end of the secular Bear this year? Because the market is a predictive, not a correlative, indicator. If the news is dreadful but those of us who are "early adopters" when it comes to investing perceive that the seeds of change are already sprouting as a reaction to the bad news, we'll start quietly buying. As others reach the same conclusion, they'll add to the "more buyers than sellers" phenomenon. And we'll then see institutions and individuals catching a later wave. Or two. Or three. But in a new Bull market, the greatest reward comes in the earliest innings…

Disclosure: I am long TOT, STO, JPM, WFC, KYE, STWD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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