Don't Confuse a Bear Market with Stupidity 23 comments
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“So when are we coming out with a tasset fund?”
“A tactical asset allocation fund?” I replied. “Mmm, it’s worth a thought, but you know what it takes to add a new product. How much demand would there be for this?”
“Are you kidding? In a bear market, people still want to make money. We need someone smart who can decide when to be in the market and when to take shelter in cash.”
“If it were only that easy,” I replied, “Tell me, who is so reliably brilliant at market timing, and willing to trade for anything other than his own account?”
“You got me there, Dr. Merkel, but we really need a product like this. It would sell like crazy.” (Note: they called me Doctor there regularly. I did not encourage it; I am not a Ph. D.)
“No doubt. I will consider it, and get back to you.”
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I had that conversation back in 1994 with one of the better pension representatives of Provident Mutual. As one of the actuaries there, I quickly realized that I had to boil any investment ideas down into very simple terms for the field force. The best explanations were rich and simple, like a fairy tale, one of Aesop’s fables, or one of the parables of Jesus Christ. That is a challenge — one worthy of the best investment minds.
The thing is, there is a constant war between two views of the market:
- Buy and Hold — Bull Market
- Trade, trade, trade — Bear Market
I don’t think either view has permanent validity. Of course in a bull market the buy and holders will crow; they are making money. And in a bear market, those with less exposure to the market will crow. Big deal. Those that are accidentally correct boast while their strategy is in favor.
So, when I read this NY Times article about diversification, I yawn. After a bear market, you decide to reduce equity exposure? That’s just fear expressing itself in stupidity. Even worse is this WSJ article, where the author is giving into his fears, and reducing equity exposure.
My point here is a simple one. Don’t confuse brilliance with a bull market. Don’t confuse stupidity with a bear market.
Very few people are good traders, such that they can maneuver the pulses of the market. For those that understand how the market works in the long run and on average, the best thing to do is to ride bear markets out. Own the best companies you can find, and adjust your asset allocation such that you can survive something worse than a bad recession. Many people over-own stocks, implicitly trusting in the naive view that they always outperform bonds. Stocks do outperform bonds, but by much less than advertised, say 1-2%/year.
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When I look at the risk cycle now, I am inclined to reduce risk, and add to safe investments. That said, I might wait a while to see if the positive momentum persists. I am gratified by the rally in lower-rated corporate bonds, but think that the risk there is growing. I am presently inclined to do an “up in quality” trade, sacrificing yield for safety. There. That is the way to go now. Reduce risk, and take the loss in yield.
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A might contend that the pricing spread you describe is fine, the Ratings are out of whack - California shows us the likely fate of a Lot of munis. Relatively lower rates on Treasuries are a bet on return Of capital as opposed to return On capital.
Deflation or inflation, I think one can reasonably expect Treasuries to beat munis from here.
(Disclosure: short munis)
And I must rise in support of Link: I've made more timing on my own behalf than I ever made "holding" at the behest of advisors.
Regarding stocks vs. bonds – the latest research shows bonds have actually outperformed stocks for last 40 years- Bonds: Why Bother?
www.indexuniverse.com/...
Even Jeremy Stiegel Read (author of Stocks for the long Run had to concede)
Buying good stocks at the right price is the best strategy, but that is easier said than done – look at GM, IBM, CSCO, INTC. GM has gone kaput – lost all its profits for last 80 years (almost its entire life). Depending on when you would have gone into IBM, INTC, CSCO, MSFT – they are at 10+ year lows.
I am totally bearish on stocks and bonds, belong to the Deflation camp.
On May 22 12:17 PM Missing_Link wrote:
> > "For those that understand how the market works in the long run
Really, I think all inverse ETFs are best for a 5-6 week period at most, and under a month with the 2x-3x leveraged ETFs.
Would love to hear more about your experiences, though.
On May 22 10:09 PM Fighting Yoda wrote:
> Inverse ETFx don't work - they do daily doubling, but over any kind
> of long term - week/month - they simply fall apart. Learnt it the
> hard way - totally stsy away from them -single ETFs are good enough.
>
The problem is that it takes a couple of years and, depending if you have a mentor, very unlikely for most people, you will lose most of your money during that "educational" phase. So, given a few years of failing, most people give up. I believe however that most can learn, if they can withstand year after year of losses, albeit a few years of losses.
I didn't have much to start with, so I didn't lose much in relative terms, but in absolute terms, I lost most of it but didn't care and kept at it. Now, I employ options in directional trading, not recommended as a way to start to learn, mind you, and have profits every week. Sure, there is the occasional "bad" week, but that's where money management comes in.
I will add that successful directional options trading is one of the harder ways to go, since not only do you have to get the direction correct, but also the time, it must happen relatively quickly, and one must factor in a technical concept called implied volatility which can still yield a losing trade, even if you get the direction right.
Still, now, there is no going back for me with "merely" trading stocks.
On May 22 11:40 AM PastTense wrote:
> Many of us fear bonds are going to do very poorly in coming years
> because of substantial inflation (and before someone mentions TIPs,
> note their inflation adjustment mechanism is the Consumer Price Index
> which significantly understates actual inflation)
it is better to control your own money and future. i too have had better results handling my own affairs. if i had listened to my ex-broker it would have been catastrophe.
adaptation turned me from investor to reluctant trader. so far so good.
> and on average, the best thing to do is to ride bear markets out."
Only if you've been clueless up to this point, then it MIGHT be wise to just ride it out.
Trading is hard but a bit of common sense goes a long ways. When the market is screaming hot and everyone says buy, buy, you should stay put but be on the lookout for a turn because that generational turn can eat up all your profits that took decades to generate. In mid to late 2007 one should have seen the collapse coming. If you didn't and you believed the likes of Jim Cramer, Larry Kudlow and the Fast Money Gang you lost your shirt and you should stop reading now unless you are willing to THINK FOR YOURSELF for a change.
We are still there and we are not through with it but even if you caught the first 50% drop and stayed out of the market you just outdid 99.9% of investors and you can now get back in 100% long (though I'd recommend doing so at an obvious low point, not right now) and just sit tight for another few decades. Better yet, watch the real data and you'll see that we have much farther to go to the downside but my point is that even playing it safe after the crash will put you WAY ahead of the typical genius who follows the pundits and "expert" analysts.
There are many pressures in the market and the long term ones are the easiest to trade as long as you can actually think for yourself and show some discipline. When "pressure" builds in the market as it did all through the 1980's and 1990's and then was patched up by Bush and Greenspan in the past decade you KNOW that the bubble will burst and all you need do is pay attention to stock prices. The 50 day-moving-average would have gotten you out in time to avoid the crash of 1929, 1973, 1987, 2000 and 2008. Each of those "crashes" occured with the market well above its trend average so while the market is below trend you should ignore breaks through the 50 dma and simply hold for the long term.
2000-2003 was a unique situation; while many see it as a true crash it was more of a head fake and looking at the real economic data showing the debt we were building up would have made that clear.
As long as you know where in the big cycle we are a little common sense will put you way ahead of the average investor. Economies need to crash every 80 years or so to blow off steam and you can't let all the little blow offs in between convince you that "things are different this time." So many people are looking to the 1970's in comparison to now and that's just killing their ability to make good decisions. The economy is deflating not inflating and we were 14x higher than the last bull high in 1966 (1,000 x 14 = 14,000) versus 2.6x of the 1966 high versus the previous high in 1929 (380 x 2.6 = 988). This is simple stuff that can't be ignored. The stock market gains 4.8% a year on average and always has, very consistently through war, despression, recession, etc. You can run that trend forever and it is always were it should be: above an undervalued market like in 1980 and under an overpriced market like in 2000. It passes through the crash of 1987, showing why that crash didn't result in worse carnage to the economy (not enough pressure had built up) and shows the market as overpriced but not way overpriced in 1966. The 1940's were consistently under the trend average as investors were averse to risk after the Great Depression and you can see the market slowly climb back to trend in the 1950's and then become a bit overvalued by 1966. Slowly as we moved farther and farther away from the devastation of the Great Depression people became more and more willing to leverage up and the stock market went along for the ride as your HELOC money went into the share price of Wal-Mart and Home Depot, Apple, Google and GM.
So where are we? Still above trend, which I believe is 6,000 for the Dow. The market will likely continue its descent until it is at least 50% of its trend average and then it's buy and hold time, if you please, or pass the salt and trade aggresively; either way you are likely to do very well for decades unless the greedy pigs who run things (and those who follow along in their wake) have really ruined our free market economy for good, but that's not likely.
"For those that understand how the market works in the long run and on average, the best thing to do is to ride bear markets out."
This is absolutely untrue. Perhaps you forgot that stocks went down 89% during the great depression. Perhaps you ignored the fact that the whole global experiment in fiat currency is on its last legs? This is not me talking, its our ex-sec of treas Paulson who said that the system was at risk of collapse if we didn't print 700 billion immediately. Doctor, do you think that printing money from thin air can fix this problem? Do you think an indebtedness problem can be fixed with more debt? Can water be used to patch a busted dam? Did you vote for McCain or Obama? Your statements do not display the wisdom it would require to have voted for Ron Paul.
"Own the best companies you can find, and adjust your asset allocation such that you can survive something worse than a bad recession... When I look at the risk cycle now, I am inclined to reduce risk, and add to safe investments."
Doctor, what ARE the best investments? What are the safe companies? How do you know they are worth anything at all? Face it, they all got prosperous based on debt taken out either by themselves or others and when the credit dries up everyone's business model is seriously impaired and in many cases dead.
Since the Japanese auto industry is widely proclaimed to be superior to our own, have a look at the balance sheet of Toyota, the Japanese flagship automaker. They have 132 b-b-b-billion in debt and only 23 bn in cash. They do not own their business, they borrowed it from some bank. Anyone paying $75 for TM shares will lose 90% of their investment over the next 2 years as auto sales cannot go back up to old levels but cash burn for debt service does not go away. Same thing for GE, the blue blood "safe" company of America. 504 bn in debt vs only 44bn cash. WOW!!! Some bank owns GE too! No doubt it will need a bail out when it cannot service the debt while making up for pension shortfalls!
There are precious few companies that are not beholden to a bank for their own balance sheet. I suppose you think someone who buys a 500k home with 20% down "owns" their home, huh? No, Doctor, the bank owns it. Maybe McDonald's is a "safe"company in your eyes because their shares have not imploded yet? Sorry, they are in debt 5:1 over their cash while their book value evaporates due to reductions in world wide real estate prices that are never coming back in your lifetime. When it comes to the books, MCD is a commercial real estate company and given the fact that its shares plummeted to $16 after dot bomb I see no reason why they will not do a repeat this time. The engine of their growth, emerging markets, is drying up rapidly because in a deflationary crash those on the margin are hurt the first and the worst.
WMT shares had an exponential run up since Greenspan removed all the leveraged stops in 1995 and when that leverage is re-legislated back out of the market then WMT, which is also heavily in debt and running on a paper thin profit margin, will plummet back down to where the fiat currency and fractional reserve banking nightmare pumped it up from. The service on the debt, especially the requirement to roll it over in a credit market filled with mistrust, is what will send many American icons to the bankruptcy courts.
So I have to ask, is everyone on Wall St as childishly ignorant as you seem to be regarding the true underlying fundamentals of the bull stock market that started since 1995?
IT WAS ALL MANUFACTURED VIA THE EXTENSION OF CREDIT AND THE ACCEPTANCE OF HIGHLY LEVERAGED DEBT.
It was, in essence, a money trick. A scam. A grift. A credit based pyramid scheme. A con job. Why do you think the heads keep talking about needing CONfidence? When the confidence is lost, the con job is over.
I urge you to stop trying to lure people back into value traps which you call the "safe companies". There is no such thing (except perhaps gold miners) in a deflationary crash. The "safe" companies will actually be hit the hardest in terms of percentage going forward because they have not taken their fair share of the punishment yet. Once people like you finally realize they are not safe there will be a mass exodus and the last guy out of the stock will be left holding an empty bag. That, dear Doctor, is how a pyramid scheme works!
IBM, for example, is headed sub $20. I know this for a fact because I can read a stock chart, understand mania theory and note that nothing exponential in finance every lasts. Not Tulipmania, not The South Sea Trading Company, not the Dow leading up to 1929, not the Internet bubble, not the Dow leading up to 2007 and not the commodities commodities bubble.
Now, for those companies which do not carry a lot of debt, their reward will be survival of the new depression, not prosperity during it. When the bottom finally does come they will rebound faster than others. While they have not taken debt on to run their businesses, THEY RELY on others doing so in order to sustain their past sales. So AAPL is going to crash just like IBM but AAPL will rise out of the ashes while IBM becomes a zombie corporation which de-leverages for a decade or two.
No amount of "don't worry, stay the course" is going to paper over the only fundamentals that matter right now which are that credit/debt destruction are effectively reducing the money supply which is deflationary.
On May 23 08:55 AM dcb wrote:
> the mechanism for tips includes food and energy in its inflation
> calculations.
You are so spot on. They have been telling us for years we need them and most of us bought into it. I went completely on my own after the brainy broker blew my account out in 2000. I have made money every year since. It's really not too hard if you are willing to put in even a little work and a good dose of logic.
Set buy and sell targets based on a index. Sell at 25% + moves and buy at -10% moves of the index. This is based on the (long term) observation that bull markets are 2.5X the a bear market.
Always have a buy and sell list ready when the indexes hit a buy or sell target.
My current buy and sell triggers (based on the March 9 low of 666 on the S&P 500 Index are as follows).
Buy triggers. 599 (if market undershoots the low of 666). I will also buy if market hits 749.
Sell trigger 833 (triggered already - this way I took some money off the table). Next sell trigger is 1049.
Here is my spreadsheet.
spreadsheets.google.co...