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Summary

  • The market is about to post its best August performance in 14 years and the S&P 500 stands near an all-time high of 2,000.
  • 2014 continues to add to gains in shareholders' portfolios after 2013 produced over 30% returns in the market.
  • So given the recent performance of the market, why don't investors feel better? Three core reasons and my market game plan for the months ahead are highlighted below.

The markets are going to post their best performance for an August in 14 years. The S&P 500 crossed over the magical 2,000 level this week for the first time in the index's long history. After posting over 30% returns in 2013, equities continue to provide solid returns to investors albeit at a much slower pace than last year. So why don't stockholders feel better?

One thing I have noticed over the past month, both in the comments from readers on my Seeking Alpha articles and at industry events here in the Miami area, is the overall negative tone on the market from both readers and from friends in the fund management business.

There is an overall cautiousness despite the complete lack of any corrections in the market for several years. It is almost eerie. These worries are generally concentrated in three core areas.

The Federal Reserve:

It is hard to believe that the Federal Reserve is finally going to end the latest of its huge quantitative easing programs after almost six years in October. There seems to be a lot of trepidation about the "training wheels" finally coming off of equities. This caution is warranted in my opinion. The market declined over 15% after the end of QE1 and more than 10% after the completion of QE2. With the market selling at significantly higher earnings multiples now that the last two attempts to end quantitative easing, will it be any different this time? Count me in with the skeptics to this question as I am in a trust, but verify mode right now.

Europe:

Escalating tensions in Ukraine triggered mostly by new Russian aggression is increasing calls for new sanctions which could push an already faltering European economy closer to outright recession. In addition, there has been a major lack of leadership from the major Western powers on how to respond to an increasingly confrontational stance taken by Putin in Russia's near abroad. Clarity on which way the West will respond is murky at best given their previous weak kneed approach to previous transgressions.

Eurozone also sees inflation continuing to fall. Consumer prices rose just 0.3% year-over-year in August, well below the ECB's target of just below 2%. Italy is in outright deflation and German retail sales just posted their largest monthly decline since January 2012.

Look for pressure on the European Central Bank (ECB) to engage in its own quantitative easing program to escalate. The Euro should continue to face headwinds. Ironically, the increasing likelihood that the ECB will intervene is keeping some of my fund manager friends from shorting the market at these levels, adding to their anxiety around their portfolios.

I would continue to avoid American multi-nationals like IBM Corporation (NYSE:IBM) or McDonald's (NYSE:MCD) that get a large portion of their sales from the Eurozone as they will take some significant currency hits to their earnings. The recent fall of the Euro against the dollar is already foreshadowing a possible move by the ECB.

The Uneven Recovery:

One of the ironies of the past half dozen years is that "wealth inequality" has accelerated under what is arguably the most progressive administration since LBJ. Over 80% of the stock market gains since the market bottomed have accrued to the top 10% of society. Asset inflation in real estate has had a similar dispersion.

While highly skilled positions remain hard to fill and are seeing solid wage growth, positions at the lower and middle end of the scale are hard to come by and show wage growth that is barely keeping up with inflation. This is one reason why lower end discounters like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) are under pressure and showing no sales growth to speak of while high end retailers like Tiffany (NYSE:TIF) are posting consistently stellar results.

It appears that the economy will again produce ~2% GDP growth in 2014, a hallmark of what continues to be the weakest post war recovery on record. To put in perspective, the previous nine post war recoveries saw annual GDP growth of over 4% after the economy bottomed. In the deep recession of 1982, the economy averaged over 5% annual GDP growth over the next four years off the bottom.

The uneven recovery is escalating the angst among low and middle income consumers who are fighting to keep up with inflation and are still scared of losing their jobs or having hard times finding one. It is also increasing the level of political rancor in the country. Finally, even those of us that are doing well are reticent to be optimistic given friends and family members that are having a much tougher time than they should be more than five years into the "recovery".

Game Plan:

My game plan remains the same as it has been for the past few weeks and probably will be so until we confirm that the market can withstand the removal of quantitative easing in October. This consists of four parts:

1) Keep a higher than normal allocation to cash in my portfolio. This cash percentage stands for me right now right at 25%.

2) Maintain a core set of large cap growth names selling at reasonable valuations in my portfolio like Apple (NASDAQ:AAPL) and Gilead Sciences (NASDAQ:GILD).

3) Sell just out money calls on more speculative names like Achillion Pharmaceuticals (NASDAQ:ACHN). This lowers the volatility of the overall portfolio.

4) Initiate new positions using just out of money bull put spreads to pick up premium income and/or gain lower entry points on equities I still find attractive like Ultra Petroleum (NYSE:UPL).

I don't foresee this strategy changing over the next couple of months. The 2,000 mark on the S&P 500 might prove to be a formidable resistance point in retrospect. My most likely outcome for equities is a stalemate for the time being.

Source: Market Posts Best August In 14 Years. Why Don't Investors Feel Better?