Learning To Be OK With Missing Out On The Last Legs Of The Bull Market

Includes: CCJ, CVX, RDS.A, SU, URG
by: Zoltan Ban

A recent Bloomberg article seems to encourage investors to stick with the market even if they believe that bull market may be nearing its end, because of potentially sizable gains.

Logic of Bloomberg article's argument seems to center on the belief that one could stay in the market and then still avoid the downturn, which ignores downside.

A wiser choice is to pick stocks within sectors that are still likely to see significant upside in case that the recovery continues, while perhaps exposing portfolio to less downside.

I was intrigued by the argument made in Bloomberg in an article entitled "Crash Course In Market Timing Shows Cost of Being Wrong at Tops". It is basically an argument suggesting that investors would be well served to ride out the last leg of a bull market, because there is still a significant chunk of profit that one would be missing out on by getting out a year too early.

Source: Bloomberg

As we can see, we are talking about significant double-digit gains that investors can lose out on, by not staying in the market until the last leg of the bull market is over. If I had a way to precisely pinpoint the market top, I would agree with this assessment. I personally do not feel that I possess this skill. Most of those who believe that they are capable of pinpointing with a certain degree of accuracy the moment when it is time to step off and sell one's broad market position are also most likely overestimating their own abilities in this regard. This is why I believe that the smart thing to do is to start adding to one's positions when the market declined by a significant amount, and start selling as the market starts providing some healthy returns, and never look back with regret.

The difficulty with timing the market

If only it were that easy to just accurately call for market tops & bottoms, most investors would be able to stop working for a living. But, as most of us know, it is really not that easy. For instance, I believed already back in late 2015 that a broadly diversified portfolio was not a safe way forward. I instead chose to heavily invest in the declining oil sector. I started buying about six months before the bottom in oil prices and kept buying, considering the further downturn to be an opportunity rather than a negative development. As I pointed out in an article I wrote meant to inform readers about my strategy to start building a position in oil and gas, I decided to buy mostly large, stable companies such as Shell (RDS.A), Chevron (CVX), and Suncor (SU). I should note that this group, which currently makes up a sizable part of my portfolio in no way under-performed the broader market, given my average entry point I built in 2015-2016. So, even though I was wrong in regards to risks of an impending recession perhaps being close enough that avoiding a broadly diversified position was warranted, I did nevertheless continue to participate in the overall market upswing. Thing is that I continue to feel comfortable holding this position, because I feel that downside in oil and gas majors is currently more limited compared with the broader market.

There are other market sectors that can play a similar role. I feel that the Uranium market, which has been battered for over a decade now would in no way be affected by an economic downturn. Nuclear power plant projects are very long-term investment projects, and it is very unlikely that they will be interrupted by a recession. On the contrary, such projects being executed around the world can be seen as a good economic stimulus which can help maintain a higher level of economic activity in certain countries. For that reason, I also started building a position in uranium miners last year. I bought Ur-Energy (URG) and Cameco (CCJ) so far, and may consider adding more either to these stocks, or buy other uranium mining stocks going forward. Aside from energy, other sectors that are typically considered as being relatively resilient in the face of possible recessions might be areas worth considering, such as defense stocks for instance. Perhaps within the context of all the latest saber rattling and already announced defense spending hikes, such stocks might not be a bad idea.

As is the case with a market or segment top, pinpointing a market bottom is equally difficult to do. Those who manage to do so most often tend to get lucky rather than do so due to skill and knowledge. The most dangerous thing that one could do if they ever do manage to accurately pinpoint a market top or bottom is believe that they can do it on a regular basis. This is why, at this point, a broadly diversified portfolio seems to be a risky proposition. It is true that another recession, therefore significant market downturn may potentially still be years away. The recent tax cuts, as well as the overall trend within the local and global economy certainly do not suggest that there may be significant danger ahead. On the other hand, there is the trade war talk, which is intensifying. Interest rates are headed higher, with no one really aware of just what level the economy can tolerate. All we know is that at government, business and consumer levels there is now more debt than there was in 2007 when the last debt bubble burst. It is therefore logical to reason that we are now far less resilient to higher interest rates than we were then.

Source: Federal Reserve Bank of St. Louis

Source: Federal Reserve Bank of New York

Source: Federal Reserve Bank of St. Louis

As we can see, aside from consumer debt, which did see some moderate deleveraging in the immediate years after the great economic crisis of 2008, the two other major debt segments saw a straight path up. When it comes to government debt, it should be expected, after all recessions lead to lower revenues, while Keynesian theory recommends governments should intensify spending during such hard times. Mention should be made of the fact that Keynes also thought that spending should be reduced dramatically once recession is over, which as we can see did not happen.

If there is one silver lining in terms of the evolution of debt in the past decade or so, it is the fact that consumer debt is the one sector which grew by the least amount since 2007. Within the context of America's economy which is home to the world's most prominent reserve currency, government finances, as well corporate debt can be theoretically taken care of directly through Federal Reserve intervention if need be. The fact that the US dollar is the world's most prominent reserve currency allows the Federal Reserve quite a bit of flexibility in reacting to a crisis by flooding the system with money, as we have already seen. Consumer debt on the other hand is more difficult to directly deal with through monetary means. In other words, there is no way to relieve consumers of their debt burden aside from lowering interest rates, or allowing them to deleverage, which means allowing the economy to slide into recession. There is of course no way of telling if and when this would happen. If it does, as is often the case it will be rather sudden, and it will lead to a stock market selloff.

Other factors, such as a global trade war, or an actual war, as is increasingly becoming possible as great powers of the world all operate in Syria in the pursuit of opposing objectives, could all derail the current economic recovery. A regional war between Iran and Saudi Arabia could erupt at any moment as well, potentially disrupting as much as 15-20% of global oil exports, which would be catastrophic if it were to be of a significant duration. These are all potential events that could potentially happen at a short moment's notice with very few if any warning signals going off beforehand. Such events are independent of where the stock markets and the economy are in terms of the economic cycle. Thing is however that given the almost four-fold increase in the value of the Dow Jones index since the 2009 bottom, there is arguably far further to fall now, than there would have been if any such events would have occurred in 2009 or soon after.

There is arguably more predictability in trying to guess the proximity of a market top based on looking at economic metrics, such as interest rates, business investment, whether there is an oil price spike on the horizon due to the supply/demand outlook and so on. Even such metrics do not necessarily provide an accurate enough guidance, because all of them could be off, or could see a reverse in trend for a variety of reasons. Correctly concluding that we are most likely within the last 12 months of a bull market is hard enough, never mind trying to stay in the market once such a conclusion has been reached, which would then involve trying to pinpoint the market top. It is very often the case that the market top is only correctly identified by most investors and analysts only in hindsight, often after the gains of the last 12 months of the bull market have been mostly or completely erased. Keeping these considerations in mind, I think it is wise to retain the discipline needed to gradually shift away from a broadly diversified market strategy once it becomes increasingly clear that there is more downside than upside. Stock picking is still possible and desirable within such a market, focusing especially on segments that have more potential upside in the event that the recovery continues for a while longer, while risking more limited downside in case that we are likely to be closer to an imminent recession than we think.

Disclosure: I am/we are long SU, CVX, URG, RDS.A, CCJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.