It Pays to Be a Fool in This Market

Bernard Baruch, one of the world’s most legendary speculators, said:s

“The main purpose of the stock market is to make fools of as many men as possible.”

Right now, that’s exactly what’s going on. And I assure you, a lot of folks will be made into complete fools in the next year or so.

Chances are though, the folks who are going to look like fools are not who you think.

A Fool and His Money

The amount of bearishness from the market commentators is as strong as it ever was. The recent rally has only strengthened their resolve.

The thing is though, market meltdowns don’t happen when everyone expects them to. They happen when everyone is feeling safe. They happen when the market is overconfident. They happen when no one can find a reason not to buy. Right now, there is none of these.

The big money managers still don’t feel safe. The CBOE Volatility Index (a.k.a. the VIX or the Fear Index) is still at 31. The VIX is calculated by taking the implied volatility of option contracts on the S&P 500.

Simply put, the VIX is a measure of “portfolio insurance.”

When the VIX is high, the cost of insurance is high. It’s like buying catastrophe insurance for a house in Florida. The cost of insurance is high because of all the hurricanes. The perceived risks are high and that risk results in a higher cost.

When the VIX is low, it shows the cost of insurance is low. Right now, with the VIX at 31, it’s still relatively high. For instance, the VIX soared to a peak of 89 during the market extremes of 2008. The VIX, however, fell to less than 10 during the steady bull market between 2003 and 2007.

Basically, the cost of insurance is still high because the perceived risks are high. That perception still hasn’t changed.

Fools Rush In - at the Worst Possible Time

Most investors were absolutely crushed last year. There were very few safe havens outside of gold and U.S. Treasuries (And how many folks loaded up on both of these seemingly diametrically opposed assets?).

Almost everyone lost money – in most cases, they lost a lot of it. The effect of that is no one wants to take very much risk.

There are hundreds of thousands of investors thinking, “Sure, inflation is coming. And I’ll essentially be losing 6% a year in real terms. But hey, that’s a lot better than 45%.” But still, the safety and security of not having to fear of having to open the monthly brokerage account statement is a welcome relief to many.

Remember, confidence is slowly gained and easily destroyed. That’s why stocks go up slowly and fall quickly. Just like the old saying says, “Stocks go up stairs and down an elevator.”

Just take a look at how long it took for the markets to get its confidence back after the tech crash. After the steady collapse of the markets between 2000 and 2002, investors didn’t want much to do with stocks. They were very few bright spots in the economy and no one knew when or how the recession was going to end.

It took two years for the “true bottom” to form. There were plenty of starts and stops. The markets would jump and then fall right back down. Most investors simply threw in their collective towels during that period. Of course, looking back, it was a terrible time to sell out of the markets.

A Fool’s Hope: Buy High and Sell Higher

Now, look at what just happened. Between October 2007 and March 2009, the markets just continued to slide. Sometimes the fall was slow. Other times the down days were strung together five or six at a time.

Any sense of confidence in the markets was completely shaken out. The downturn was sharp and fast. Everything was going down.

Even the most experienced analysts and traders were a bit thrown off. Retail investors – a.k.a. average Joe investor – reached a near panic. They wanted out, wanted out completely, and they wanted out now.

Too see how badly they wanted out during this downturn compared to the tech crash, just look at the chart below which tracks mutual fund inflows and outflows.

Pretty big difference between the two, huh?

The data in the chart comes from the Investment Company Institute and it was compiled by analysts at the QVM Group. The chart shows how long it’s going to take to “recover” from the recent market downturn.

The VIX shows us the swashbuckling confidence and excessive risk-taking isn’t coming back for a long time. Fear is still high and the rules of investing when fear is high is a bit different.

A Juiced Market

This is a time when market movements accelerate everything.

Like most baseball players, the market is juiced. Everything is bigger and faster. Gains are bigger and come faster. Losses too are bigger and come faster. Volatility is still exceptionally high.

This is a key part of the long-run bottoming process. Remember, the market’s goal is to make a fool of as many people as possible.

That’s exactly what it’s doing right now.

The market starts going up for a while and sucks people in. Then it falls down again.

It moves up a little bit more and sucks more in. Then down.

It’s an unpredictable cycle that repeats again and again. It always ends the same though. It ends with one big rally that sucks everyone in.

And that right there is why I’m not bearish yet. We haven’t had the “big one” yet. Heck we might even be in it right now. But it’s not about to end now.

First, there are still $3.7 trillion on the sidelines. That’s a lot of money that hasn’t come back into the markets yet.

Also, the money from the $787 billion stimulus package has not been spent. According to Recovery.gov, less than 6% of it has been spent so far (insert joke here about how amazing it is to see how slow the government is at spending this money or about how big an “emergency” it really was).

Finally, the market is rising which helps create a positive “wealth effect.” With more than 70% of Americans owning equities directly or indirectly through mutual funds that has a big impact.

Think of a 55 year-old person who saw their $1 million portfolio fall to $500,000. It took six months to get used to the loss, but now it’s up to $600,000. Yes, I realize inflation will make that much less valuable in the long-term, but that $100,000 paper gain will impact whether he takes the wife out for dinner or not.

Those are all factors why I believe this rally could last a lot longer than most expect. Sure, there are plenty of problems lurking on the horizon. There are Alt-A mortgages and option-ARM’s which need reset. And interest rates will play a big role. And huge government deficits which have no near-term solution (well, at least one which is politically feasible anyways).

Coming Full Circle

That’s why I think this market is a “Fool’s Paradise.” And depending on which stage in the investor life-cycle you’re at will have a big impact on how well you do during this extended rally.

I remember when I just started investing. I did exceptionally well. I bought stocks as they were rising. I would sell after they climbed a bit. Some would go up 10% in a year. Others would go up 50% or more.

In hindsight, I had no idea what I was doing. But my strategy was simple. I bought stocks which were going up.

As I learned more, I became more confident in my skills of fundamental analysis and others. I reached the second stage. I knew something, but not enough. I loved how complicated it was and learned how to look at companies from a fundamental perspective.

I would wage a personal financial battle against the markets. I would find something I considered of value and buy it. And continue to buy it. There was no discipline or focus on risk. Of course, I was a bit overconfident. I was downright dangerous.

Here we are a few years later and I feel lucky to have reached the final stage. The point where you know one thing – don’t bet against the markets. It’s also the point where you ask, “How much can I lose,” before asking, “How much will I make?”

That’s why, despite all the bad news out there and the plenty more which is to come, there are plenty of opportunities here. One of our mantras has been to take what the market gives us and, even though we’ll have a few more down days like today, the market is giving us opportunities on the long side.

This market may be a “Fool’s Paradise,” but could also be dangerous. That’s why I’m long stocks and buying more, but also applying strategies to stay safe in this market.

The rally will end…eventually. But I think that’s quite a ways off. In fact, I’m more excited than ever for the summer. And in the next Prosperity Dispatch we’ll look at three areas which will pay off exceptionally well in the next few months.

Comments

[F. Bradeen:]

"Don't confuse brains with a bull market." is an old apt quote. Or at least a strong bear market rally. I look at your same data and come to the opposite conclusions. I.e. I see too much bullishness around. I see, via our own chart, money flowing into mutual funds and I find the Vix quite complacent relative to the recent past. I see the public gobbling up new issues of bank shares. I see obvious market manipulation ala last Friday's last few minutes ramp up. Yes. There may be some residual strength left in this rally. But it's bullish complacency I am seeing and am concerned about..

Jun 04 04:55 PM

[Jasper M:]

Author confuses bearish market commentators with bearish market participants. Wonder where he was in Aril?
And to save time I'll second Mr. Bradeen on all points.

Jun 04 05:18 PM

[logicalthought:]

I don't know why you think you have such a variant view. Just about every commentator I've seen or read lately is either outright fundamentally bullish or says this is "a bear market rally that could run quite a bit further." I don't know if I've seen ANYONE (except maybe that guy who runs "The Prudent Bear Fund" say "sell everything right now and get short, because this market's imminently about to go down." In fact, I'm a fundamental bear and *I'm* not ready to say that yet either... And that scares me.

Jun 04 05:38 PM

[htex:]

Ahhhhhhh, FEAR of missing all that upside. FEAR is a great motivator and when it turns, oh what a spectacle of human nature at work. What else is supporting this rally again?

Jun 04 05:49 PM

[thiazole:]

There was no manipulation last Friday - look at the 2 day chart between Friday afternoon and Monday morning. You'll see a smooth transition. Investors realized on Friday that when the GM bankruptcy was finalized on Monday that a level of uncertainty would be removed from the market and it would go up. Much of it was probably short covering to avoid exposure to Monday.


On Jun 04 04:55 PM F. Bradeen wrote:


> I see the public gobbling up new issues of bank shares. I see obvious
> market manipulation ala last Friday's last few minutes ramp up. Yes.

Jun 04 05:51 PM

[Dave Wrixon:]

Not just last Friday. I am guessing it is being manipulate by those holding derivatives.


On Jun 04 04:55 PM F. Bradeen wrote:

> "Don't confuse brains with a bull market." is an old apt quote. Or
> at least a strong bear market rally. I look at your same data and
> come to the opposite conclusions. I.e. I see too much bullishness
> around. I see, via our own chart, money flowing into mutual funds
> and I find the Vix quite complacent relative to the recent past.
> I see the public gobbling up new issues of bank shares. I see obvious
> market manipulation ala last Friday's last few minutes ramp up. Yes.
> There may be some residual strength left in this rally. But it's
> bullish complacency I am seeing and am concerned about..

Jun 04 05:58 PM

[logicalthought:]

Oh, stop with the "manipulation" (all of you)... If "they" are so great at "manipulation", then why did the market dive down into the 600s a mere 90 days or so ago? Or did "they" do that, too, so "they" would have a chance to buy "your" shares really cheap? Here's a little secret I learned from one of "them": "They" can't manipulate YOUR stocks if you trade wearing a tin foil hat.


On Jun 04 05:58 PM Dave Wrixon wrote:

> Not just last Friday. I am guessing it is being manipulate by those
> holding derivatives.

Jun 04 06:12 PM

[woollyB:]

Before you take anyone's market advice these days, you need to know what that person was recommending in summer/fall 2007, spring 2008, fall 2008, etc. If they weren't sounding the warning bells in 2007, then you're taking a big risk if you assume that person has somehow wised up in 2009.

There are precious few analysts who had it right, but they are worth seeking out. Most of the people dispensing advice took it on the chin alongside all the retail investors whom they purport to advise.

Personally, I see optimism rising fast, and the next leg down starting within the next few months.

Jun 04 06:41 PM

[thiazole:]

Just look at the thumbs on this forum - every time someone states something remotely bullish, no matter how true it is, (s)he gets lots of thumbs down and every time someone states something bearish, no matter how ridiculous it is (like the Dow is going to 1000), they get lots of thumbs up. When bulls start getting thumbs up every time they post something stupid, then I'll agree with you.


On Jun 04 05:38 PM logicalthought wrote:

> I don't know why you think you have such a variant view. Just about
> every commentator I've seen or read lately is either outright fundamentally
> bullish or says this is "a bear market rally that could run quite
> a bit further." I don't know if I've seen ANYONE (except maybe that
> guy who runs "The Prudent Bear Fund" say "sell everything right now
> and get short, because this market's imminently about to go down."
> In fact, I'm a fundamental bear and *I'm* not ready to say that yet
> either... And that scares me.

Jun 04 06:44 PM

[Fighting Yoda:]

"Fool’s Hope: Buy High and Sell Higher" - this also is Cramer's philosphy. Things go higher till they stop going.

Yes, 'Markets can stay irrational longer than....'

Jun 04 06:45 PM

[Nathaniel C:]

Marc Faber said it best: this is a market rally driven by trillions of dollars that have been printed by central banks around the world. That money has to go somewhere and it is going into stocks and commodities. Once the central banks take back all this money and start raising interest rates, this rally will be seriously challenged.

Jun 04 07:16 PM

[LatStephen:]

This article reminds of this comic
www.dilbert.com/strips.../

Jun 04 08:23 PM

[logicalman:]

i said just about the same thing a few times sometime back in may...it's not good to be a perma-anything...you have to be very flexible in these mkts....but that doesn't necessarily mean that you change your mind like a weather-vane..look and listen, keep an open mind,get all the info you can,even from those you disagree with, and always remember that more often than not mkts can be irrational..but in the end they are always right!!!


On Jun 04 06:44 PM thiazole wrote:

> Just look at the thumbs on this forum - every time someone states
> something remotely bullish, no matter how true it is, (s)he gets
> lots of thumbs down and every time someone states something bearish,
> no matter how ridiculous it is (like the Dow is going to 1000), they
> get lots of thumbs up. When bulls start getting thumbs up every time
> they post something stupid, then I'll agree with you.

Jun 04 08:43 PM

[Larry House:]

Typical market hype. The market may go higher, but that doesn't mean it is wrong to be cautious now. The market also has a way of punishing bulls who think the sky is the limit. There is something in this market for everyone--places to be long, and places to be short. Make choice, ante up, see what happens.

Jun 04 08:50 PM

[cameroni:]

Can I go out on a limb here a little...

I am a bear too,..but I have a worrisome perspective lately that does not jive with any assessment I have seen anywhere else. I will confide that I now see this market as rising through to the fall, just in time to meet the avalanche of borrowed money the government is infusing into the system. It would mean that the bear rally could meet serious inflation and no significant pullback would ever materialize. Markets would simply keep rising as the dollar continues it's downward march.

I have always stated no two recessions are alike. And puzzled how this one may differ. We know (or feel sure) that we will be facing serious inflation sometime in the future. The Fed is promising it by monetizing debt.

With the recent reluctance of Asia to continue buying our debt at levels necessary to finance the government agenda, it suggests conclusively that monetization over the next year or two will seriously damage the dollar. That's highly inflationary and we all know. The real questions come Fall will be how we invest to keep up with that devaluation and do more than just break even.

Could we really be headed into a situation where we are net losers despite how fast markets rise? Will the lunatics who called for a Dow of 45,000 actually be crowned as correct in the inflation of the future?

I think at this juncture we need to dispense with a lot of theory from the past and look frankly at what is taking place in real terms. The Fed will take us inflationary. The markets are rising. The dollar is falling. Bond buyers are looking for deals in commodities and shunning our debt. Gold is on the rise and the trend is certainly up. The finer list goes on and on and on.

This Bull may gore us yet in ways we never imagined.

Cam

Jun 04 11:41 PM

[thiazole:]

I agree with you to a point. Here is what I see happening, so compare and contrast and you'll see that they are pretty similar. I see the market picking up wind again soon - maybe starting with tomorrow's employment data if it is as good as rumors suggest. It will hit a resistance point that stalls it out in the fall and will get stuck in a holding pattern for several months - maybe even half a year. It will have one final short lived hurrah after that holding pattern breaks until the Fed starts raising interest rates to combat a serious inflation problem. That is when market valuations will drop. I personally don't think it will be a fast crash - the inflation will prevent that. But it will crash for 2 or 3 years straight - maybe 10% a year, but after inflation it will be MUCH worse than that. Those will be ugly and painful times, but it could have been worse.


On Jun 04 11:41 PM cameroni wrote:

> Can I go out on a limb here a little...
>
> I am a bear too,..but I have a worrisome perspective lately that
> does not jive with any assessment I have seen anywhere else. I will
> confide that I now see this market as rising through to the fall,
> just in time to meet the avalanche of borrowed money the government
> is infusing into the system. It would mean that the bear rally could
> meet serious inflation and no significant pullback would ever materialize.
> Markets would simply keep rising as the dollar continues it's downward
> march.
>
> I have always stated no two recessions are alike. And puzzled how
> this one may differ. We know (or feel sure) that we will be facing
> serious inflation sometime in the future. The Fed is promising it
> by monetizing debt.
>
> With the recent reluctance of Asia to continue buying our debt at
> levels necessary to finance the government agenda, it suggests conclusively
> that monetization over the next year or two will seriously damage
> the dollar. That's highly inflationary and we all know. The real
> questions come Fall will be how we invest to keep up with that devaluation
> and do more than just break even.
>
> Could we really be headed into a situation where we are net losers
> despite how fast markets rise? Will the lunatics who called for a
> Dow of 45,000 actually be crowned as correct in the inflation of
> the future?
>
> I think at this juncture we need to dispense with a lot of theory
> from the past and look frankly at what is taking place in real terms.
> The Fed will take us inflationary. The markets are rising. The dollar
> is falling. Bond buyers are looking for deals in commodities and
> shunning our debt. Gold is on the rise and the trend is certainly
> up. The finer list goes on and on and on.
>
> This Bull may gore us yet in ways we never imagined.
>
> Cam

Jun 05 12:28 AM

[dcb:]

cetin go away


On Jun 04 05:44 PM thesmartest wrote:

> up go the markets yet again....DJIA 8850 soon
>
> I'm a bear but I would never ever short the market now. Wait till
> churning & distribution
> sets in, which may not be for a very long time.
> this bull market cannot be stopped (for now). look at GOOG POT MOS
> AAPL MA V BIDU FXI EWZ
> and other cheap dollar, globalist plays. They are on a tear.
> Why anyone would try to fade this rally is baffling to say the least
>
>
> good articles: fly2.ws/9SdkpLU

Jun 05 04:56 AM

[dcb:]

the macro factors do not line up with the markets performance.
pe rations are at apparently an all time high
there is clear manipulation
we have gotten returns that should have taken a year take 3 months
net money flow was out of the market from april 20 to end of may. if things aren't being manipulated how did this happen?
know this the higher the market is manipulated up the more fucked we will be because higher oil, lower dollar, higher inflation.
the net result is that we will be much worse off than if the market went down.
the market is being manipulated up for the benefit of the banks, which does not appear to bother our government.
the point I am attempting to make is that there are two opposite forces at work and that the two are not compatible.

the fed is doing everything it can to bailout the banks and prop up housing, this kills the dollar and drives up inflation. keeping the market up avoids pension problems, keeps our banks solvent (they aren't), and means they don't have to go for more bailout money.

I believe the "cure" is worse than the illness for america, but if I am a wall street banker I want a bad dollar, inflation, etc. Note if I am goldman holding up the markets I have many positions. I am making a killing, you are getting killed. I get my always bigger bonus, you get unemployement, and stagflation.

the aren't green shoots, there never was. You can't try to pull off two contrasting things at the same time. It does not work and will not work.

Jun 05 05:11 AM

[dcb:]

the market is being manipulated until the fools rush in.

Jun 05 05:14 AM

[thiazole:]

Uh oh, the newly unemployed dropped to 345,000 last month - it must be Goldman tricking us again somehow (note sarcasm).

Jun 05 09:46 AM

[Old Trader:]

Nope, that was probably caused by the number of people who's benefits ran out and they fell of of the rolls.


On Jun 05 09:46 AM thiazole wrote:

> Uh oh, the newly unemployed dropped to 345,000 last month - it must
> be Goldman tricking us again somehow (note sarcasm).

Jun 05 06:03 PM

[thiazole:]

Those numbers have nothing to do with unemployment benefits. They are simply the difference between the number of new jobs and eliminated jobs from the previous month.

Jun 05 09:21 PM