Wednesday, June 15, 2011

Taking a look at the bigger picture ,,,,,,,

I thought I’d take advantage of a quiet day in the office and catch up with some blogging ……. There’s not many people who can openly say that without fear of their employer giving them “the boot”- not only do I not have that fear, but I know I have my employer’s blessing ….. wow! I’d like to take a step back and see where we are. Not that one should only reflect on quieter days, but its certainly a good opportunity to do just that!

With the US markets currently down some 8% from the recent peak, with the Nasdaq in negative territory for the year and many other markets either share a similar fate or are fast approaching, there is certainly a lot of fear out there. What do we do now? Do we buy? Sell and wait for more certainty before getting back in? Wait and see? The first question that needs to be addressed is what sort of an investor am I? Many investors are currently wondering why they are not traders. The last decade has seen the markets go absolutely nowhere with a huge amount of volatility. Buy and hold has not worked in the main. One must remember though, that:

1. yes, your neighbor may have sold at the top, but if they didn’t get back in, then they are not necessarily better off.
2. You have many neighbors, many more of whom would have bought at the top ….
3. and it’s only the successful ones that will be shouting their stories!

Generally, trying to mix the trader and investor approaches does not work. If you would like some blend of the 2, you should allocate part of your money to each method as the rules and psychology are completely different. The trader MUST NOT care about fundamental values- his timeframe is far too short. The investor has to trade on fundamentals, without getting caught up by the emotive side. Indeed, the investor will typically be buying the stocks that are hated by the market in general and traders in particular.

The Markets have had a very negative tone over the last few weeks. This was to be expected. In Q1:
· Cyclical indicators reached historically high levels, and was tracking well above its normal level for the stage of recovery we were at.
· Consumer confidence was dented by a whole host of problems.
· High commodity prices were denting the consumers and putting corporate margins under pressure, but the weak consumer meant that companies were unable to fully pass on the costs.
· Wage costs are rising sharply in Emerging Markets.
· Productivity growth is unlikely to be strong due to the lack of investment over the last 3 years.
· Forecasts, which on the whole had been based on continued positive margin expansion was already at the highest since 1956, despite a tepid economy and surging input costs.
· Emerging Market Central banks have started on the monetary tightening route.

And we haven’t even begun to talk about outside factors, such as the end to QE2 and Fed induced liquidity, or the sovereign debt problems that have plagued us for 18 months and show no signs of letting up, or geopolitical tension in the Middle East/Africa, or natural disasters/tsunamis and their repercussions on global demand/supply, or a housing market is bobbing along at the very bottom, with 1 in 4 Americans in negative equity with potentially much more downside, or even the still weak labor market.

There is no doubt about it, the economy is definitely cooling off, as it was this time last year. However, now it is different. Last year, Mr Bernanke through the market a lifeline with a new round of liquidity expansion. Last week however, he delivered an even more sobering outlook, but this time without the lifeline (just yet anyway- I mentioned here that the stock market, and Fed, and just about everyone in between is seemingly caught in a catch 22 situation: QE3 is seemingly being priced in by stocks ...... however for QE3 to actually happen, stocks would have to fall approximately 15-20% from their current elevated levels!!! I feel that QE3 was the main factor in propping up the market to such an elevated level, if there is no hint from the next Fed meeting (next week) as to the onset of QE3, we may be in for an interesting market- which of course would give the Fed the ammo needed for QE3!!!

Another interesting observation is that whilst the economists have been cutting their numbers, the equity analysts have yet to follow suit. If they do, then suddenly market valuations are not as compelling as they seemed.

All this sounds very bearish, and one can well understand the want/need to take some money off the table and wait and see. Weakness in the economic data was expected. In addition, the supply chain disruptions from Japan and consumer cutbacks from higher oil, was also expected, with consensus opinion that the tepid recovery will continue after these aberrations. There is always the worry though that the economic weakness is the sign of something much worse. This currently seems quite an extreme view, as even the cautious camp are predicting a slower rate of growth rather than an outright recession.

There are some real doom and gloomers too, who want to extrapolate to another lost decade plus. For me, the last decade was an exception. It started where demand and sales had been brought forward over fears of Y2k. This was an exceptional and unprecedented boom, which was only intensified by the onset of the internet. The decade ended with a financial crises of unprecedented proportions. We started with an atypical peak, and ended with an atypical trough.

For the investors out there, I would take advantage of the fear. Though I would imagine that there is still some more downside, I feel like the slowing economy story is fairly reflected in prices. Over the course of a business cycle, stocks are undervalued and trading below historic norms. Yes, China, and other Emerging countries are tightening, but this is a positive. They have already been appropriately tightening for a year now, and seem to be successfully navigating growth with manageable inflation. Incremental Emerging Market consumer spending eclipsed US consumer spending several years ago, with the Emerging Market consumer to drive global growth for years to come. And there are already indications that even those who have been hardest hit by the Japanese earthquake are almost operating close to full production.

Over the past few months, I have been saying how the market is not exciting, the risk reward is not compelling. The markets are now at their most compelling, valuation wise. Despite expecting some more down side, I would begin to close underweights and for the investors to build positions. The markets themselves seem quite healthy, in the sense of strong balance sheets, leverage as low as it has been for the last 20 years, banks more willing to lend, buisness climate indicators still close to their highs. By all means trade the fear, trade the exuberance. But don’t get caught up in it yourself. Stick to your system- if everything is within normal ranges, then there is no reason for alarm. And also be wary of the news. The news is about problems and potential disasters. If it’s the talk of the town, then it is already reflected in market prices. Look for the unexpected, or if something unusual is happening.

Happy Investing/trading!!!

For the record, S&P 500 currently at 1267!

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