Lessons from a Market 'En Fuego'

Includes: CAT, SU
by: Roger Nusbaum

The stock market has clearly been en fuego for an awfully long time. As has been the the case the whole way up from March, people can spin all information available any way they want to conclude what they want - but the market has gone up regardless of anyone's conclusion.

The other day Laszlo Byrini made a comment that I have made many times before (not sure who originated it) which is that the bear case is always more compelling and more articulate. I can't make a convincing bull argument. Ages ago (the end of 2008), I made the case for a big snapback rally based on the simple fact that no matter how bad things are (were), after hideous declines the market retraces a noticeable portion fairly quickly.

At some point the current snapback rally went from ordinary (in magnitude) to out of the ordinary. One reader noted that the only thing the market has going for it is sentiment. I don't know if that is the only thing, but I remain quite skeptical. In weighing out the positives (there are positives) and the negatives, I think the balance favors the negative by a wide margin. The worst economic event in 80 years resolves itself like a (almost) normal recession? That just doesn't make sense to me.

That being said, a point I made countless times about why 100% cash is a bad idea is that you end up missing huge rallies. Lagging a huge rally is different than missing a huge rally. At one point, our cash level was in the ballpark of 30% plus the double short ETF and a market neutral fund or two. Through the course of the year I have added slowly to clients' equity exposure with a discretionary ETF, a purchase of Caterpillar, an increase in the tech ETF we use and recently adding Suncor (NYSE:SU).

Year to date, I am a little behind the market but still have a fair bit of dry powder, so it is possible my risk adjusted stats look decent. Our clients did not drop anywhere near what the market dropped, and despite lagging this rally clients are now down high single digits from the quarterly high water mark from 2007.

I mention this to create a proper (in my opinion) long term context. I talk often about viewing this over the course of the entire stock market cycle (a bit of process perhaps gleaned from John Hussman). People all too often focus on absurdly short periods of time. Quick, did you beat or lag the market in Q2 2004 - and by how much? You don't know from memory, because it doesn't matter. We've had a horrible, but not unprecedented, decade for equity returns. What matters is whether you avoided some of that decline. Actually, what probably matters more than that is how much you saved over the last decade.

Anyone of at least mediocre investing ability will have periods where they are ahead of the market and periods where they are behind. That just goes with the territory. If you know ahead of time there will be periods where you "beat" the market, then there is no reason to get cocky about it. Likewise if you know there will be periods that you will lag the market there is no reason to get despondent about it.

The way I view things, there are times to smooth out the ride (not pull off the road) and times to take every bump as it comes. You cannot be right all the time but you can reduce the consequence of being wrong.