I have to do my best to lead the market. Not because I’m brilliant or clairvoyant. But because I’m lousy at following. Let me explain…
No one at our firm is a market timer. Instead, we rebalance client portfolios based upon economic and geopolitical events, the markets, investor sentiment and a more-difficult-to-define metric I’ll mention in a moment.
That does not mean, however, that we think secular market timing is hocus-pocus. On the contrary, one of the bedrocks of our success (or pure good luck, if you can’t bring yourself to accept the following hypothesis!) is that there are times to be mostly or 100% in the market and times to be mostly or 100% out of the market.
We don’t try to pinpoint market tops and market bottoms. We leave that to others who are brighter, better followers of one system or another who can place their faith in Fibonacci progressions, flags, pennants, saucers and teacups, Elliott Waves, and other such “visible” indicators. We do look at the charts but we do so to review long-term price action, moving averages, and a couple other key indicators.
When it comes to following, I get an uncomfortable edginess when I find the media, Wall Street analysts, and institutional investors in agreement with my analysis. CANSLIM, relative momentum, and such, therefore don’t work for me. I just know I’ll be the last guy on the train just as it plows into a bigger oncoming train. Fortunately I realized this a few decades ago and found something that works better, at least for me. And that is…
Rather than buy and hold through every market, up or down, just because I am no good at trend-following, I stair-step out of the market as it approaches nosebleed territory and I stair-step back in as most investors are getting more and more green about the gills because of the market decline. That is my “market timing.”
A caveat: Because of this stair-stepped entry and exit, my analysis of events, markets and investor sentiment often lead us to buy too early and to sell too early. By “too early” I mean that we usually begin buying before the final bottom is in and we typically begin selling before the final top is in.
This doesn’t bother us. We are making the decision to buy when most are clamoring to sell at great prices. This gives us the luxury of selecting -- like Billy Ray Valentine (played by Eddie Murphy) in Trading Places -- which of the numerous sellers we’d like to select from. Conversely, we make the decision to sell when others are clamoring to buy. We therefore enjoy the luxury of calm and deliberate positioning, without the emotion that typically occurs at tops and bottoms.
SA readers can clearly see the results of this shortcoming to my methodology. After the sickening 7200-point plus decline from October 2007’s 14,000 to 6726, I recommended going long on March 3rd ( see article here). Were I capable of fine-tuning Technical Analysis better, I could have waited until March 9th when the Dow closed even lower, at 6547.
It isn’t that I missed those extra 179 points that makes this strategy difficult for many to accept, however: it is the emotional turmoil that a number of people feel when going against the crowd and the carnival barkers from Wall Street. On that day, when I began buying long ETFs and beaten-down bank preferred shares, one of our younger clients called to say I’d given her a terrible upset stomach. “Everyone knows,” she told me, "that the next stop on the Dow is 6000 -- if it holds." As a matter of fact, she had just heard some talking head on CNBC claim we’d be at Dow 3000 by July. I, on the other hand, felt great relief knowing that 90% of the commentators were of the opinion that the market “had” to continue going down.
By the end of that month, while I was happy to ride with our long positions, I cautioned readers not to chase the markets if they were just entering the game (here) and said, in the Full Disclosure to that article, that as the markets approached their 200-day moving average, we would be sellers. “We will sell 50% of all as/if the market rises toward 8500 or so and will sell more if it goes to the 9000 area.” Notice, please, the “as/if.” I have no conceit that I will be right and others wrong – this is just what works for me. Your mileage may vary.
Then on June 4th I set off a firestorm in 7 ETFs to Short Right Now. It seems the tide had turned and all those previous super-bears were now super-bulls and deeply offended by my decision to go short! No doubt I sold too early in the 8200-8500 range – the Dow ultimately reached 8799 on June 12th. But I needed to sell for my clients and me to sleep at night.
When you don't trust the market, Cash is Good. When I advocated protecting our portfolios by going short, the comments included, “.. you are going to get torched shorting those... I hope for their sakes that your clients are aware their hard earned money is about to go up in a cloud of smoke...”
I envy the people who can make statements about the market with such certitude. In nearly 40 years, I have never “known” what the market was going to do. I just use the best indicators and tools I can and try to get it as right as I can as often as possible. The market was 8750 the day I wrote the article and it’s 8150 as of last week’s close, so I don’t feel too bad for myself or our clients – but, yes, by “leading” rather than following a favored indicator and by “stair-stepping” in and out, I will never have the bragging rights that reporters glom onto – “So-and-so picked the exact top!” I’m still a lousy follower, or I might be a more successful market timer.
Instead, I have to do what the indicators I’ve come to trust tell me to do even if it makes some of our clients take Maalox when I go long as a result of seeing a changing trend in a bear market, or when I take some money off the table when the party is in full swing and I begin to wonder what stupid thing the drunks will do next. If I’m correct right out of the box -- which seldom happens! -- I might accelerate the rate of withdrawal. If I’m wrong – as often happens! – I take a little more out a few days later, a little more the next week, etc. The blended average of these moves means that we never get the exact top or the exact bottom but we most often get to take a little or a lot out of each major move.
I said at the outset that we rebalance client portfolios based upon economic and geopolitical events, markets, investor sentiment and another metric. I am preparing now for the flood of criticism that will likely launch in… 3, 2,1, Launch! The final metric is that I trust my gut – as you should trust yours. How many times have I heard a new client or subscriber say, “I knew I should have sold on such-and-such date. But I listened to the experts and they said to buy, so I did.”
We may not be able to put our finger on exactly how it is that our life and market experiences come together in our subconscious. This may sound too soft and squishy to base a decision on, especially when some 25-year-old kid from Goldman Sachs who got the job because Daddy got him into (and endowed a building at) Harvard, trots out something “solid” like charts and graphs. But it isn’t squshy at all.
How many times have you gotten a bad feeling about staying in the market but let the talking heads override the sum of all your life experiences (i.e., your gut.) Conversely, how many times have you said, “Hmmm… The Dow is down 7000 points -- this now seems way overdone. As long as the world isn’t coming to an end, I’m thinking the market will rally.” That is your experience talking, but too many of us let the current headlines overrule our own experience.
If your gut tells you something doesn’t feel right, it probably isn’t just the street-corner Polish dog you had for lunch. We are the sum total of our experiences and our outlook. For those of us of a certain age, those experiences include the go-go 1960s and subsequent 30% decline; the rise to 1000 in1973 and 40% crash in 1974; the sideways markets of the ‘70s that then took nine years just to get to 1100; the rise up until the Crash of ’87; the subsequent skyrocketing caused by the productivity unleashed by the Internet; the dot.bom of 2000; the monster rally of 2002 that took us to an all-time high of 14,000; and the despair subsequent to the declines from the October 2007 high -- that looks like every other despair I’ve seen in my lifetime.
What about you? Seen one or two of these markets up close and personal? Listened to the gloom and doom from people trying to sell you their bearish newsletter and telling you the markets would never recover? They were wrong. Or those who told you the next stop was Dow 35,000? They missed the memo, as well.
So where does that lead us right now? Based upon economic and geopolitical events, the markets, investor sentiment (and my gut,) not in a good place. I don’t see light at the end of the tunnel 6 months out. I see light a year out, picking up a good head of steam a couple months before the Congressional mid-term elections of 2010 -- but the markets typically don’t look ahead that far.
Economic and geopolitical events: Our nation has printed or borrowed some $10 trillion and are set for another $3 trillion this year. Worse, we used to define the numbing hand of socialism as "government [rather than individual] ownership and administration of the means of production and distribution of goods." I guess, if we are a capitalist rather than a socialist nation, auto-making, health care, banking, our pension system, and deciding how much money bondholders receive in bankruptcy, must now be exempt from that definition!
We are deluding ourselves if we believe that the same national government that has run the Social Security system, Medicare, the Post Office, the Veterans Administration and income tax collection into shabby disorder will somehow save us by nationalizing these other endeavors. I see at least a year of increased saving (see here for investment implications), entrepreneurship, and American roll-up-your-sleeves productivity increases (see here) before we get out of this mess.
The markets: During the recessions of my lifetime, the most-followed stock indexes dropped to single digit P/E ratios as companies began to make sales but no one cared. In this recession, earnings are plummeting but Wall Street’s Happy Talk has prevented most investors from worrying about it: if earnings are less bad than the latest round of brokers’ reduction of estimates to ridiculously low levels, then it must be OK. It isn’t.
P/E ratios today are actually rising, not declining! The most recent earnings estimates for the S&P 500 stocks this year is $28.51. With the S&P 500 trading at 879 on Friday, this puts the average P/E of the top 500 companies in America (by market cap) at 31. I’m used to seeing that sort of valuation when I’m looking to start stair-stepping out, not when I’m looking to add to positions!
Why? Because I think that, if I’m in a car hurtling at 40 miles an hour downslope toward a cliff, slowing the car to 30 mph by sticking my leg out the door is not the solution. I’ll still go off that cliff, minus one leg. Better to exit the vehicle and pick some wildflowers while I wait for the inevitable crash – minus me in it.
Investor sentiment: Investors are just plain tired ofThe Bear. But, despite what we may have heard in the Dusty Springfield song, “wishin’ and hopin’” won’t prevent the markets from reacting to events and earnings. And whistling past the graveyard won’t keep the ghosts from chasing us. I see investor sentiment as anxiously one-sided. In the unavoidable gap between writing this and seeing it published, the market may be up or down 200 points. If it’s up, I will write a few more puts on inverse ETFs and say “thank you” to those willing to increase the premium spreads on up days…
Gut feelings / life & investing experience: Finally, we come to my gut – or yours. For me, a continuation of the good times and a belief that we are now ready to embark on the next bull just doesn’t “feel” right. A dozen years of analyzing why that nagging concern is there would just leave me a dozen years behind. Somewhere in my past I imagine there was a similar situation, or many, and they typically went a different direction than the Happy Talkers are now predicting.
So we remain positioned as noted in the Full Disclosure below. And if our positioning proves accurate this time, be advised: as/if the markets decline to the point where economic and geopolitical events begin to show glimmers of real hope and change, not more of the same government over-reaching; as/if PEs adjust to more reasonable valuations; and as/if the mood on the Street turns to despondency and hopelessness -- as I believe it will -- I’ll write more puts, this time on great companies and long-side ETFs, and buy the safest big-dividend-payers. A word of warning: As usual, I’ll probably start buying too early…
FULL DISCLOSURE: We remain long a few bank and healthcare preferred shares that we believe still offer good value and high yield; we are long option-writing closed-end fund GGN because, through thick and thin, we like their portfolio of gold and energy companies; we own lots of cash equivalents (our biggest positions) in short-term bond funds like SHY and TUZ and slightly longer-term (5-10 years) BND, AGG and TIP; and we are short, mostly via inverse ETFs like SKF, SRS, SBB, EUM, PSQ, SH, and DOG.