"You can’t beat the crowd by being the crowd. Yet, time and again, this is exactly what most investors attempt to do.
The investment manifestation of this is called momentum investing -- buy high to sell higher. Yet the foundation of this approach is anchored in a self-delusional belief that one can..."
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The stock market rally since early March appears to have three distinct phases to it.
The first phase was the backing off from the economic abyss. The second phase was a bounce to fair value normalcy. The third phase (the one we are in now) is what I would call the return to business as usual phase (or “Recession. What recession?).
From where I sit, the first two phases were justified on many levels. Both phases featured massive amounts of government intervention combined with strong technicals to produce a rally to fair value. The elimination of the tail risk of the Great Depression II was followed by the above consensus macro economic readings (my MERI indicator), which was reinforced by the above consensus earnings results of 2Q09. Stocks rose to a reasonable fair value. So far, so good.
Unfortunately, at this point the seeds of questionable earlier decisions began to bear fruit. (Now, this going to sound very libertarian, so here goes.) Instead of pursuing the necessary cleansing process that all excesses produce, the Obama administration (which includes the US Treasury and the “independent” Federal Reserve) opted for a massive debt transference from the private to the public sector with the hope that time will heal all wounds. Along with this decision to socialize the bad behavior of the private sector most responsible for the crisis, the financial services industry, the Obama administration supported its core structure built on the laissez-faire era of the past two decades, accepting the largely unsubstantiated argument that financial innovation is a vital and necessary good for the economy.
With the government’s tacit support of the status quo, the investment mood shifted from fear and concern to hope and then enthusiasm.
The evidence of this mood shift back to the animal spirits days of yore came from a logical source – the financial services industry, the very sector of the global economy that provided the financial innovation grease to the out of control freight train of credit. And what better symbolic locomotive than Goldman Sachs, whose earnings report of July 14th whistled the bad old days were back in action. At this point, the Obama administration swung into action – with silence.
With its absence of outrage, the increasingly politically tone deaf Obama administration sent the public policy signal that its okay to bring the world economy to its knees, its okay to get bailed out with taxpayer money, its okay to shrink the competitive landscape (via Bear and Lehman’s demise), and its okay to return to the way things were – big profits and in your face fat bonuses.
The product of this wink and nod to Wall Street was the backlash at town hall meetings, which were as much about fairness as they were about healthcare reform concerns, a paranoid view of government, and a reactionary view of what constitutes being an American. It also produced an enthusiasm for stocks and an implied return to the bad old days.
Investment Strategy Implications
When you combine all these factors with the massive amount of investment capital ($3.5 trillion) still sitting in the near zero interest rate money market sidelines, the rising belief among many institutional investors that P/Es above their historical average are justified in the current low inflation environment, and the fledgling confidence that the global economy is on the mend* (along with the blind faith that the economic data from China is real), it is understandable how valuation levels could get to where they are today – stretched.
The investment question then becomes, “Is this a solid enough foundation upon which sustainable bull markets are built?” I have my doubts.
*I suggest reading Nouriel Roubini's comments in yesterday's FT.
"Romantics have a word that best describes the stock market’s current levitation act: nostalgia. The newly emboldened buy-the-dips crowd, flush with cash and longing for the bygone days of beta-inspired rates of return, perceived the recent market swoon as yet another opportunity to defy valuation gravity and are apparently attempting to levitate stocks to new highs. Will it work?..."
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My interview with the author of "A Modern Approach to Graham and Dodd Investing" and Chief Economist at Pittsford Venture Group includes a historical perspective on why stocks are overvalued, the importance of value investing using book value and dividends, the exceptional use of optionality into valuation models, and the factors surrounding the uncertainty of top line (revenue) growth.
All Beyond the Sound Bite podcast interviews can be found at beyondthesoundbite.blogspot.com
To listen to this week's interview, click here
Back on August 3rd subscribers to my weekly newsletter - Sectors and Styles Strategy Report - read the following:
"China may become the bigger fly in the bullish ointment. Unlike the US, China has spent all of its stimulus package money not on consumer demand related areas (where it is most needed) but on more infrastructure projects. Since the US consumer is and will remain in balance sheet repair mode for a while and developed economy consumers (Europe and Japan) reluctant and/or unable to pick up the slack, end user (consumer) demand must materialize from emerging economies. With savings rates very high in China and other developing economies, expectations of V-shaped global economy recovery of a sustainable nature (meaning balanced and asset bubble free) seem fairly unlikely.
Therefore, a close eye should be kept on China and the very real prospect that a bubble burst may occur in that country. Should such an event occur, the global growth story becomes highly suspect, and equity values based on a global V-shaped recovery and expansion very problematic."
At the end of the day, somebody has got to buy something from someone else. The government may be the lender of last resort but it is not the buyer of last resort. That title belongs you and me - the consumer. And, despite its best Keynesian wishes, the prospect of demand being a guaranteed result of fiscal stimuli remains an unresolved mystery. Therefore, as helpful as next year's conveniently politically-timed US stimulus package will be, it cannot be, nor should be, counted on as lifting the world economy out of its end user dilemma. Moreover, government schemes like "cash for clunkers" get you only so far. They're like a life preserver keeping one's economic head just above the water, and nothing more.
Investment Strategy Implications
When stocks moved away from the abyss a certain sense of relief was taken to a modestly enthusiastic extreme. The more optimistic drank the valuation kool-aid of born again bullish investment strategists. "The more things change, the more they remain the same" became the mantra as business as usual replaced the panic-driven mindset - business most unusual.
With the past few days of market decline, perhaps reality will begin to sink into the valuation equation. Hopefully (but not likely), the vital focus on what is necessary for a sustainable global economic recovery will take center stage. And with it a concentrated effort to appreciate the end user dilemma.
"I've stated several times that I'm not a chart-pattern guy. I've found that trying to predict the future of any asset via the patterns its chart reveals yields, for me, a 50/50 proposition. Yet, there's some merit to chart-pattern recognition -- many others do follow the dark art. Therefore, since the name of the investment game is to outwit your unseen investment opponent (that’s how you generate alpha), seeing what they see (and possibly believe) can be a productive exercise.
To illustrate, let’s look at a basic chart of gold..."
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My interview with the Chief Market Strategist with the wealth management firm, RDM Financial Group, includes the prospects of a sub-par economic recovery due to rising US consumer savings, deleveraging, increased regulation, and increased risk aversion, the structural advantages of emerging economies over developed economies, and the longer-term risk of deflation.
All Beyond the Sound Bite podcast interviews can be found at beyondthesoundbite.blogspot.com
To listen to this week's interview, click here
"Now that buy-the-dips has made it an investment hell for those with large sums of cash (and a very low exposure to stocks), I want to offer not words of encouragement (hang in there, bears stuff), but an investment opportunity that may ease some of the pain if you missed the rally and now don’t know what to do. Before I describe this investment, let me touch on a few points that may help place the current environment in context.
There are 2 points in market cycles when investors who have a high percent of their assets in cash are most unsure how to proceed. One point is when..."
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My interview with the assistant editor of the Financial Times and author of "Fool's Gold" includes key aspects of financial innovation, the consequences of a reluctance to lend by financial institutions, the utility qualities of the financial services industry, and the transitional nature of both the financial services industry and the global economy.
All Beyond the Sound Bite podcast interviews can be found at beyondthesoundbite.blogspot.com
To listen to this week's interview, click here
When: Today, 12:30 to 2 PM (lunch from 11:30 to 12:30)
Where: New York Society of Security Analysts offices (1177 Ave. of America's, NYC)
Who: Mary Ann Bartels, Todd Harrison, Brad Hintz, and Don Rissmiller; moderated by Vinny Catalano
What: GEM - government, economy, and the markets; plus - China; financial services industry; hedge funds, and more
To learn more about the event, click here
To attend, show up (website registrations have ended).
