The sun will come out, tomorrow
Bet your bottom dollar
That tomorrow, there’ll be sun!
Just thinkin’ about, tomorrow
Clears away the cobwebs and the sorrow
‘Til there’s none!
-Annie
1. The credit crisis we've been expecting is here.
2. Inflation on the things we need is on the rise.
3. Unemployment is increasing.
4. We're at war on many fronts.
5. Social acrimony is beginning to build.
6. Federal authorities -- from the Treasury to the Federal Reserve to the European Central Bank to the Securities and Exchange Commission -- intervene in our markets daily, making our lives as professional money managers more difficult than they should be in a truly "free" market.
7. Real estate prices are plummeting.
8. Credit is available for only a few very healthy companies - and for those that the Fed feels are important enough to bail out. The rest of us have to pay for our mistakes.
So, are you ready to walk off the nearest ledge yet?
The economy and the credit/equity markets are anything but a walk in the park these days. But hey, this isn't a game for amateurs, and this cycle will most certainly show us who a) understands the big picture, b) knows how to measure risk and c) knows how to preserve capital. Why? Because the sun will come out tomorrow.
Tomorrow may be a bit far off, but it's out there. The goal now is to make it there with your capital intact, and even with some gains along the way.
The difference between realists and “perma-bears” is this: “Perma-bears” wake up praying for rain and don’t like to plan for tomorrow. Realists, on the other hand, look to get through the rainy days, and then pounce when the sun's about to peek out again.
I consider myself a realist.
How Far Away Is "Tomorrow"?
Ah yes, the $64 billion question. Over the last few years, I've written a few different versions of the roadmap I expect financial markets to follow. No matter what methodology I use, I keep coming up with a "tomorrow" of mid- to late 2010 for equities.
This doesn't mean, of course, that money can't be made between now and "tomorrow."It just means that high-quality fixed income securities, low-beta investing and a hedged technique are the order of the day.
Folks are starting to figure out that traditional long-only investing means that you have to be invested for a long time. I have no problem with that philosophy, provided your time horizon is 100 years and you don’t mind 15- to 17-year periods where you don’t make any money (like the one we're in now).
Frankly, I have yet to meet an investor with a 100-year time horizon and the patience to sit through a secular bear market in stocks - and the volatility that goes with it.
Why Is 2010 "Tomorrow"?
I'm a big believer in cycles. The greatest cycle of them all, and the one that I believe most influences markets, is the presidential cycle. For those not familiar with it, it goes like this:
1. What every first-term President wants is a second-term.
2. What every second-term President wants is:
a) a great legacy.
b) their party to remain in office.
The numbers speak for themselves: Stock prices and presidential approval ratings are almost 100% correlated. Since folks making money are much happier than those watching their portfolio values dwindle daily, this makes sense.
According to a Pepperdine University study, if you invested $1,000 in the Dow Jones Industrial Average on January 1 of the first year of every Presidential term and sold on October 15th of the second year for every year since 1950, your $1,000 would today be worth approximately $650, without adjusting for inflation.
On the other hand, had you invested $1,000 on October 15th of the second year of every term and sold on December 31st of the last year of every Presidential term since 1950, your $1,000 would now be worth more than $70,000. Can this be a coincidence? I think not.
History shows us that fiscal and/or monetary stimulus appears in the third and fourth year of terms, which, in turn, helps the economy and markets - under normal circumstances. The election comes, folks feel all warm and fuzzy, and then they vote for the incumbent.
At least that's supposed to be the way it works. But, alas, this time's truly different.
We've seen every kind of stimulus known to man (and I'm sure we'll see many more before tomorrow comes), yet the real economy and markets haven't responded. It's like being a doctor who calls for the crash cart and applies every emergency technique available, but has the patient die anyway. I really don't like using that analogy, since our family unexpectedly lost our 8-year-old Lab, Luke, last week, but it's the one I think most apropos.
If I'd told you a year ago that we'd have the Fed backstopping the JPMorgan (JPM)/Bear Stearns deal and creating all sorts of ridiculous term lending facilities, that the money supply would be growing at alarming rates while Fed funds fell from 5 1/2% to 2%, you'd have thought that the economy, credit and equity markets would be roaring, right?
Indeed, they are roaring, but in the wrong direction. So once the election (which should be a delightful mudslinging affair) is over, no matter who's victorious, the stimuli we've witnessed may very well be removed. And if the economy and markets haven’t responded to this latest record round of stimuli, just take a guess at how they'll do without it. Imagine a cardiac ward without a crash cart, and I think you'll get the picture.
There are other reasons to expect a 2010 low: Secular bear markets tend to last 16 years or so, which for new folks in the business will feel like an eternity. The preceding secular bull market lasted 18 years, from 1982 to 2000, and it was the giddiest secular bull market of them all. With that incredible run now well behind us, we suggest this current secular bear market will take the biggest toll as we recover from the last party-induced hangover of 1982 to 2000.
It's okay by me, since I'm positioned in a risk-averse fashion, tight risk controls firmly in place. Along with these long-term secular moves come shorter term cyclical moves lasting 3 to 4 years. Consider that the secular bear started in 2000 (at the height of the dot-com era), followed by a 3-year, gut-wrenching, 50% cyclical bear move into 2003, which in turn led to a 4-year, 100% move back to the 2000 highs by 2007.
It’s funny how arithmetic works. If you'd simply stayed invested the whole time (from 2000 to 2007), you'd have nothing to show for it except a lot of aggravation and massives losses in "emotional capital." I firmly believe that a vicious cyclical bear (within the context of an ongoing secular bear) began in July 2007 and will last the typical 3 to 4 years, bottoming out in mid- to late 2010, with a mind-numbing S&P 500 target of 700 to 900 or so.
I realize this all sounds terribly bearish. But if you flip it around. you'll see what we're really facing is an exciting period of opportunity for those who understand the big picture and are willing to adapt to the world around them.
What if I told you that I thought a 2010 low in the 700 to 900 range would be one of the best buying opportunities you'll see for quite some time? For those who've been "long only" since 2000, it would be just another rally back to my 2000 break-even point. But I fully expect this secular bear to end 15 to 18 years after 2000 at around the same levels of the 2000 S&P 500 high in the 1500 to 1600 range - which would be quite a nice move up from 800, no?
This is why we must admit where we are, not hide from it, work twice as hard as the competition - and be ready for almost everything in between.
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