There is a lot of good news out there these days. The S&P is flirting with 1000, people are pointing to a bottom (no longer just predicting), and traders are having the time of their lives. Yet, all of this news seems to come with a 'buyer beware' sign. Here are four examples:
1) Christmas in July - This most recent highlight IMHO points to some of the momentum that has been sustaining the stock market, and the economy in general. Here we see that the customer is given incentive to 'shop till you drop' with the notion that this will lift spirits. What I'm a bit surprised the article doesn't focus upon (probably to deter criticism of negativity) is the effect such programs will have upon the winter season. I'm predicting another one of those unpleasant October 'Black' days (Black Monday, Black Tuesday, Black Anyday, take your pick), and I originally thought that dismal Christmas projections would be the cause. This is now beyond the idea phase and looks more like a certain reality.
2) Cash for Clunkers - It would be funny if it didn't affect so many people's lives, but I must notice how convenient it was for the government to roll out this program after the collapse of GM. Perhaps the government's bailout will turn into a sterling success after Congress approves another couple billion dollars of pork for this nationwide program and stealth bailout of the nationalized auto industry.
Let's combine these top two examples into an interesting (but very short) case study on automotive incentives - the employee discount program. Here we have the Big Three offering what had to be the last hurrah before the big plunge a couple of years ago. You would have thought that given the strength of the economy way back when that programs like these wouldn't have been necessary to entice consumers, but desperation seems to know no bounds.
To echo the Christmas in July concept, it seems 'nothing is sacred'. We all know what happened to auto manufacturers after their discount program - it makes you think about what awaits retail (and the economy as a whole) this winter.
3) Calling the Bottom - I linked Mr. Hui's article after he posted this wonderful picture from Newsweek's cover story. The metaphor is masterful...the 'bubble' of people's hopes that this recession will finally end burst by the pin of the expected dreary 'recovery'. There is a dearth of actual good news, only that the bad may cease to get worse. Some may liken this to fertile soil for optimistic minds, but I must call to attention the consumer balance sheet - notice how asset-wise, households are at 2004 levels, but liability-wise, are still where we were in 2008. Given that the disparity between 2004 and 2008 liabilities is a whopping 30% of GDP (over $3 trillion), this smells of a major shift by the consumer from drawing credit to paying down liabilities until some sort of parity is reached. What this also translates to is a very subdued outlook for businesses dependent upon consumer spending (70% of GDP). Finally, remember that 2004 was still at the height of the housing bubble - asset prices may have further to fall, and may plunge us further back into history regarding aggregate wealth. This puts the consumer's credit rating as a whole on risky territory, given that debt-to-assets on aggregate is already past 30%. The government's balance sheet is much, much worse, so to expect more relief from that source may risk insolvency (i.e., hyperinflation).
4) Buy Long Term is Dead - This will probably draw some criticism, but I believe the shift from fundamental 'buy long term' strategies (even with the less than benign 'widow stocks' fallacy) to technical and momentum strategies poses by far the biggest risk to anyone bullish on today's stock market. There have been many critiques lambasting Ben Graham/Warren Buffett styles of investing to the point where a significant minority of financial planners are shifting to trader-oriented strategies. Retail investors are also pulling out of mutual funds in order to brave the wild.
All of this translates to a shift in investor sentiment from fundamental value styles like Jeremy Grantham's during October - March, to Mr. Kenyon's picture of 'sheeple'. Momentum trading, with terms such as 'candlesticks' and 'gravestone dojis', smack more of your most recent World of Warcraft role playing experience rather than anything to do with investing in the stock market.
Let's think of the impact - a large fund that has actually profited from this mess (Goldman Sachs (GS), anyone?) decides on a low-volume day that the music has ended, and finds a seat for itself - it closes its positions, and sits in the sidelines. 'Fund B', an acolyte of the momentum crowd, smells a shift, and notices that the market has crossed some sort of resistance threshold, and also sells. Shorts get wind of this activity and begin accumulating positions. Funds C-Z get involved. THEN the retail investor panics, and oh, the momentum!
Notice this has nothing to do with anything other than one firm getting ants in the pants, and the power of momentum afterward. Yet, from the perspective on market prices, it is all-important - anyone buying against such a stampede may find themselves getting trampled. Furthermore, there is scant evidence (in the US, at least) of any improved fundamentals (see points #1-3). The 'weighing' of the stock market for the long term does prove to be very light indeed.
To conclude from these four points, I predict a collapse in US stock market prices in October - when people begin looking at the Christmas season and less importantly when the Clunkers program expires. It fits the historical pattern of having your most spectacular bad news fall on that month, and sets up the stage for your typical spring rally the following year. It may not seem that typical given the magnitude of the collapse we just had and the surprisingly strong rally afterward, but it will definitely rhyme with history.
I also appreciate Grantham's ability to hedge his bets, so I will not directly act upon this, but will ready cash reserves for a time when the fundamentals demand action yet again. At most I may purchase some December puts to hedge my positions, maybe even buy some extra for leverage. So far, I've had a very good, if not exceptional, crisis, and plan to continue my winning streak.
Disclosure: The author holds TIP for a majority of his cash position, as well as a couple emerging market ADRs and conservative US stocks
