Equities Get a Kick in the Pants

The bell rang to start the fourth quarter with domestic equities taking one right where no one wants to take one. My original opinion about what would happen was that stocks would bottom in the second quarter of 2009 (probably later than March though); then I added on that I thought there would be one more scare the hell out of them decline which has not happened (yet?).

Maybe it started yesterday, maybe it didn't or maybe that will never happen, but as opposed to worrying about will it drop again in a painful way, I would rather think about if it does happen, what action should be taken, what is the view from 30,000 feet and what is it from 60,000 feet. Thinking about this stuff now while there has been no emotional reaction is a good way to avoid dumping all your stocks at the wrong time.

Over the last month or so I have added Suncor (SU) and iShares Emerging Market Infrastructure ETF (EMIF) for clients. At the same time the position in SDS has shrunk down to 1-1.3% of the portfolio, there is still some cash and a couple of small positions in absolute return funds (one of which is flat and the other is down 8 or 9% or so).

Excluding yesterday, the portfolio has been moving closer to the market than it has in a while as a function in increasing the equity exposure by 4-5% with the two relatively volatile names mentioned above. As a function of the defense still in place, though, I didn't drop the same as the S&P 500 yesterday. Between 1070 and 950 on the SPX I would expect to track somewhat closely to the market and if it breaches 950 I think, but can't guarantee, obviously, that the defensive holdings would kick in a little more and I would start to look less and less like the market. If conditions warranted I could also add to the SDS position, which for now would be my preference rather than selling anything -- but that could change of course.

For me that is the view closer to the ground. At 30,000 feet the market rallied 60% in six months. Regardless of whether you are in the bull or the bear camp, what is the market likely to do immediately after such an essentially straight up move? Even if you're in the year end 1200 camp there is no reason it can't go there via 850 (year end 1200 is not what I think will happen).

Much has been made about the few times that stocks say one thing and bonds say another, with the result having been that bonds were right. The monster rally has overcome a lot of reasons of why stocks should not go up, which is of course very normal (think the 75% rally in the early 1930s) but with that as the backdrop a rest or one more run down that scares the hell out of everyone becomes very plausible. If it never happens, great!

From 60,000 feet, longtime readers may recall my philosophical belief in never going 100% cash on a tactical basis (changes in life circumstances are a different story). 100% anything is a big bet, as is 0%. Hopefully no one reading this blog back then did go 100% cash. That being said, if you're at your target allocation and the market scares the hell out of everyone but you take no defensive action, okay, but what will happen in the future? From the biggest picture sense we know the S&P 500 will make a new high again. Obviously we do not know when, but it will happen. That will happen regardless of whether the S&P 500 goes down to 800 (or any other number) or not.

An indexer may respond that I am making the case for passive investing. Well, I don't know about anyone else, but I would rather not have my portfolio drop 30% in line with the market. The things I write about doing in the name of defense have no guarantee of working, but I believe history is on the side of these sorts of things and certainly are an attempt to avoid the full brunt.

If you invest in stocks you are going to go down in value sometimes. Down a little is something investors need to live with, but I want to try to avoid the full consequence of down a lot. If it works, great, if not, it is not the end of the world.

Comments

[Larry House:]

All investors would prefer to avoid large drops in portfolio value. I think the market is returning to roller coaster mode, and only the tenacious will hold on. No one knows what is going to happen, so too large a bet on anything is inviting trouble. The Fed is on hold for a LONG time. Lack of growth is still the issue. Easy money is good for stocks; lack of growth is bad. Good dividends in solid companies can help smooth out the ride. For better growth prospects, look outside the U.S.

Oct 02 02:28 PM

[Shaggieman:]

Hey Larry,

Did you see the below article. The Fed may not have a choice here.
If they stop buying treasuries and want the rest of the world to the rates have to raise. I don't think 2% say would be a big market killer personally.

October 1, 2009, 11:33 am

Alan Greenspan, Welcome to Club Wagner
By David Leonhardt
Andrew Harrer/Bloomberg Alan Greenspan, former chairman of the Federal Reserve.
From Bloomberg:

Former Federal Reserve Chairman Alan Greenspan said the U.S. will have to both tighten credit and raise taxes as the economy pulls out of the worst recession since the 1930s.

“The presumption that we’re going to be able to resolve this without significant increases in taxes is unrealistic,” Greenspan, 83, said in an interview with Bloomberg Television yesterday.

We founded Club Wagner earlier this year here at Economix. It’s a club for anyone who acknowledges that taxes must rise in coming years, to repay our current debt and to cover the cost of the kind of government voters have made clear they want — a government that includes Medicare, Social Security, the military and more.

The club is named after Adolf Wagner, a 19th-century German economist who predicted that taxes would rise as societies became wealthier. “As people grew more affluent,” the writer Matt Miller has explained, “they’d want more of what only government could provide — a strong military, public order, good schools and assorted welfare benefits, services that private citizens would have trouble arranging for on their own.”

We welcome you, Mr. Greenspan.

Oct 03 12:34 PM

[Mad Hedge F...:]

zdr For the last six months there has been a great big whopping contradiction in the markets. The stock market has been discounting a return to the “Roaring Twenties,” while the bond market has been anticipating the return of the “Great Depression.” After yesterday’s publication of the Labor Dept.’s September nonfarm payroll number showing the loss of another 263,000 jobs, it looks like the bond market now has the upper hand. The really disturbing aspect of this number is that 57,000 teachers were fired, as states chop budgets to the bone. This is really eating our seed corn by the handfull. Stocks have dropped 5% from last week’s peak, as the bond market soared, the ten year yield reaching nosebleed territory of 3.05%. My call to buy the TBT, a leveraged bet that US Treasury bonds would fall, is starting to look a little green about the gills. The dollar still maintains its flight to safety status, which to me, is one of the great ironies of all time. It’s like that reprobate, alcoholic uncle with the bad teeth, who, when your car breaks down in the middle of a downpour in a bad neighborhood, will always let you crash on his sofa. Let’s call him your Uncle Sam. You have to hand it to PIMCO’s inveterate card counter, Bill Gross, who says this is all about transitioning to a “new” normal of 1%-2% real GDP growth. That’s why he was loading the boat with bond yields at 4%, a ballsey move at the time, which now smells like roses. I guess that’s why they call him the “Bond King.” As for me, I’m never wrong, just early. Sometimes way early.

Oct 03 12:48 PM

[goalposts:]

"From the biggest picture sense we know the S&P 500 will make a new high again. Obviously we do not know when, but it will happen. That will happen regardless of whether the S&P 500 goes down to 800 (or any other number) or not."

This is a stunning statement to make. We absolutely do not know that. The mentality that the U.S. market will always, sooner or later, come back and make new highs, is what got a lot people to hold on to their 'nasdaq 5000' purchases and who are still, 10 years later, sitting at an over 50% loss. Long term buy and hold in the market of a country 12 trillion dollars in debt is too risky for me.

If one really believes the market will always make new highs, why bother to make defensive moves?

Oct 03 01:02 PM

[Old Trader:]

Roger,

Is it safe to assume that the percentage of SDS in the portfolio is the result of market action (your longs have been rising in value, while the dollar value of your SDS has been shrinking), rather than active action on your part, in terms of lightening up on hedges?

Oct 03 01:44 PM

[searcher:]

Pick good enterprises. Cheap stocks of good enterprises make for good stocks. Not saying cheap stocks make good stocks as enterprise must be good. Cheap stocks for good enterprises paying reasonably secure dividends make 'must' buy stocks. Hey, that's now out of fashion as such behavior leads to the now discredited 'buy & hold'. What to do? The hell with fashion.

Oct 03 01:54 PM

[Roger Nusbaum:]

yes other things up and SDS down. If, I say if, someone takes no other action then a position in SDS would hedge progressively less of the portfolio on the way up and progressively more on the way up.


On Oct 03 01:44 PM Old Trader wrote:

> Roger,
>
> Is it safe to assume that the percentage of SDS in the portfolio
> is the result of market action (your longs have been rising in value,
> while the dollar value of your SDS has been shrinking), rather than
> active action on your part, in terms of lightening up on hedges?

Oct 03 03:36 PM

[Roger Nusbaum:]

This not being true means that the US economy is now always and forever ruined. If you actually believe that then yes my comment would not stand up.

I do not ahve that opinion. The building block is that yes the SPX will grow back at some compound rate, my take is a rate below normal. The reason to take defensive action, aside from minimizing emotional responses is that occasionally things come up in our lives that we must spend money on in an unexpected fashion. If you started out with $500,000 in 2007, then fully cut in half with the market only to find out at that moment you must pay for something that cost $40,000 your financial plan might be ruined. If in a similar circumstance you were down 30% in a down 50% world you might be able to recover from that, certainly have a better shot at recovering anyway.


On Oct 03 01:02 PM goalposts wrote:

> "From the biggest picture sense we know the S&P 500 will make
> a new high again. Obviously we do not know when, but it will happen.
> That will happen regardless of whether the S&P 500 goes down
> to 800 (or any other number) or not."
>
> This is a stunning statement to make. We absolutely do not know that.
> The mentality that the U.S. market will always, sooner or later,
> come back and make new highs, is what got a lot people to hold on
> to their 'nasdaq 5000' purchases and who are still, 10 years later,
> sitting at an over 50% loss. Long term buy and hold in the market
> of a country 12 trillion dollars in debt is too risky for me.
>
> If one really believes the market will always make new highs, why
> bother to make defensive moves?

Oct 03 03:44 PM