Archive for August, 2010

We really don’t know where the markets are going from here. We are in a range bound market, where the only certainty seems to be that whichever direction we go for a week or two, we go back in the opposite direction with about the same velocity. Will the next breakout be towards the upside or downside? As market realists, we are totally stumped as to the answer to this crucial question. Will emotions reign? Rational thinking and valuations? Very hard to know at this point. But, what a cottage industry of guessers we are creating.

The Bears are out in force, making predictions that can make them famous. After all, don’t we all want to follow the thinking of the person who “got it right”. Bob Prechter is a well know follower of Elliott Wave Theory. More importantly, he is no dummy. He knows that if you make 10 predictions, you have a better chance of being right once and that people will forget the other nine predictions. So, a couple weeks ago, he predicted Dow 1000!!!! Ouch!!! Is that impossible? No, but neither was the prediction by bulls in 2000 of Dow 36,000. Both are highly unlikely outcomes to a realist, but they cannot be rule out entirely. Now, Prechter predicts a 20% decline in stocks as being on the horizon. This doesn’t negate his Dow 1000 prediction, but certainly gives him another chance to be a “genius”.  It is like the lottery-you want as many tickets as possible to increase your chance of picking a winner!

SoGen’s Albert Edwards is predicting an S&P 500 drop to 450, a drop of about 60%. Gold hawkers are out everywhere with their bear stories-that equities will crash, the dollar will disappear, etc.  These horrors cannot be ruled out by a rational person, but they are highly unlikely outliers in the future’s possible outcomes.

On the flip side, the perma-bears continue to function as always. It is always the right time to invest and they can always show you why. When desperate, they will find non-causal links that are mind bogglingly stupid (i.e. 7 times out of 10 the Dow rises by more than 20% when the New England Patriots lose their opener by more than 7 points)! Stocks are cheap they cry and the rally is just beginning. We rationale folks can’t rule out everything they say either.

Realists need to resist all this noise. Most likely the market is range bound today by one essential truth-the market has it pretty much right and stocks and other assets are pretty fairly valued. If that is the case, we can expect stocks to rise at a fairly slow rate in the coming years, but do it with a great deal of volatility, if that unfolds, we won’t have a new “genius” who made an amazing call on the markets meteoric rise or fall.

This morning on National Public Radio, the Market Watch Report spoke of the huge outflows year to date in domestic equity mutual funds. The analyst posited that people had gone through too many bad markets and lacked confidence in the market and economy now. She said she believed a permanent reduction in allocation to equities had taken place.

Our view of this is quite simple. First, people have been systematically led to believe that investing in stocks for the long run is safe and effective.  The truth is that research shows a lower allocation to stocks (and to bonds!) than the traditional portfolios typically make is simply a better way to go. You can increase your returns and decrease your risk by adding other types of assets to the mix. This fact is not welcome in traditional investment houses, but is born out in many places- We recommend either Dr. Craig Israelsen’s 7Twelve or Mebane Faber’s The Ivy Portfolio as a great place to start to educate yourself.

Second and just as important, there are thousands of mutual funds and the majority of them are not managing your risk. They are concerned about benchmarks, style boxes, all sorts of things about which you could care less. What you care about is your money!!! You entrusted it to professional managers in order to make it grow through the miracle of compounding. You value return on capital, but also need return of capital. The majority of domestic equity mutual funds are not set up to protect your investment in bad markets. If you were told this when making an investment, you would probably not hire the manager. Would you go to a doctor who promised to take good care of you when you are well but who would rather not treat you when you are sick? That is essentially what you are getting from many fund managers. Good results when the market is healthy and poor results when the market is ill. Not enough-so, outflows make a lot of sense to us unless you find funds that put your interests first.