I have had very light equity exposure for an extended period of time with periods of being net short to being fairly long. Fortunately, with the indices having been range bound, the opportunity cost has been insignificant. As I mentioned in a prior note being bearish is exhausting, lonely and counter to my natural optimism (although I do admit to always maintaining a healthy dose of cynicism). Imagine taking your child to see 101 Dalmatians and loudly rooting for Cruella deVille to come out on top. Your kid shrinks away to another seat on the other side of the theater while others shun you. That’s how bears are treated.
I continually second guess my investment thesis, trying to see what the other side sees. I weigh the inputs underlying my stance, marking them to market. I try to remove the bias of my position as I seek additional data that is either supportive or unsupportive of my position. And of course, there is always the fear of acting from emotion that prompts a change in thinking, a feeling that you weren’t invited to the party, of being left out. And most of all, there is that greatest fear of all, of having reversed course at absolutely the wrong time. And in full disclosure, I have not always made the turn in a very timely fashion. I did well in 2008 but hardly made any money in 2009. Although I was still ahead of the game, it still didn’t feel good missing out on a ripping bull market move.
So where am I now? I am warming up to the market. Why? Well, I have often said I have seen this movie before and it ended badly but maybe there will be a different ending to this installment because everyone else had also seen the prequel to the 2011 financial crisis. My ending has banks struggling to raise capital, some, like Dexia or perhaps Greece, going belly up, credit continuing to tighten, economies contracting - the culmination of all these fears and others I haven’t listed causing a massive wave of selling. But guess what? Merkel and Sarkozy and the more responsible members of the G-20 and EU were also around in 2008 and they have no interest in revisiting that scenario. Granted they have waited too long and the cost of delay has ratcheted up the price of a cure. Germany and France have the most to lose by not putting forth a viable solution. While expectations for a total and complete solution are still high, they have been ratcheted down enough to be attainable, or near attainable with the promise to be completely resolved in the next 3 to 6 months. Shock and awe is not in the cards and everyone knows it. But will they give us enough to put a floor under the market and cause under invested funds to chase performance? I think so.
Swimming upstream, against the tide of bullishness that is the unwavering stance by the vast majority of pundits and market participants is difficult enough but imagine the flood gates being opened and the water gushing at you as you flutter kick your portfolio like a foam kickboard. The world is awash in liquidity. It all comes down to not fighting the Fed. But the much maligned U.S. Fed has recruited a legion of Central Bankers to fight the battle: the EU, IMF and China. This is a massive liquidity push by every printing press on the planet. So for now, I am entering into surrender negotiations and further increasing my exposure further.
I am by no means becoming fully invested for I still have that evil twin whispering in my ear. The global economy is in terrible shape but what do I know that others don’t? I don’t have an edge on China – it’s a property bubble that has already begun to leak – but the Chief Communist (as opposed to Chief Economist) knows that. I think that will end ugly but they can throw enough money at it in the interim to allow the S&P to rise to 1250, a random number, while their market declines. Europe is in recession but that thinking is convention and is nothing that $1.3 trillion can’t cure.
The most alpha will likely be generated through commodities and materials – the most economically sensitive investments - but I can’t go all that way in. There is too much risk in case I am wrong. I do like the fertilizer companies for the long term and although recovering, they have been beaten worse than a Middle Eastern dictator. I still prefer the more boring fundamentally, bottoms up investments epitomized by Allscripts-Misys (NASDAQ:MDRX), Coca-Cola (NYSE:KO), Qualcomm (NASDAQ:QCOM), Wellpoint (WLP), Nii Holdings (NASDAQ:NIHD). My risk is in bottom fishing on Hewlett Packard (NYSE:HPQ) and, dare I admit it, Research in Motion (RIMM). I cut back my Euro short against the dollar but will rebuild that position again at some point.
How long the cure lasts is what keeps a lid on my exposure. At some point austerity leads to slower growth and U.S. economic policy is non-existent as Washington remains rudderless. Everyone believes China will bail out every local government, corporate and individual spectators but I don’t. After all, they are communists and not prone to providing handouts to failing billionaires or local governments who have repeatedly disobeyed central government directives. There will be some pain to teach them a lesson.
I won’t be discouraged if there is a sell on the news mentality once the EU deal is announced. And I am rooting for another delay in the announcement because that means they are still arguing – eh, negotiating. And I expect leaks from the negotiations to cause some volatility. We should continue to move higher, perhaps rally 20% before going lower, likely hitting prior lows.
Whoops, there I go again.