November 19th, 2014
by Rob Isbitts, Sungarden Investment Research
First, get your mind out of the gutter :). This is not an article about skinny-dipping. That's in next week's blog (ok, kidding). Rather, this week's blog title is from a Warren Buffett quote. The full quote: "you never know who's swimming naked until the tide goes out." Pretty funny stuff from a fellow who spends a lot of his time in the exact center of the U.S. (Omaha, NE), nowhere near an ocean.
Buffett was referring to investors who manage to do quite well when the market environment is friendly. But when the going gets tough, the tough can lose lots of money. Unfortunately, since speculation, leverage, day-trading and other forms of investment gambling are often done on behalf of investors (by hedge fund managers and others), those investors can be unsuspecting victims when the proverbial tide goes out.
At Sungarden, we are increasingly concerned that the tide is going out. We point to tremendous weakness in the stock market's technical position, with charts deteriorating in many areas we track.
Of great significance, is the recent announcement by our friends at Leuthold Group (a veteran global investment number-crunching firm). Leuthold's Major Trend Indicator (MTI) fell into negative territory for the first time in several years on October 7. While not designed to be a short-term timing indicator, we have come to respect such signals as critical inputs to our own investment process. After all, the MTI is comprised of hundreds of indicators, all compressed into a single reading on reward/risk tradeoff. And, like Leuthold, we have taken our investment positioning down, not to "it's a crisis" levels, but rather to "let's be very careful" levels (no, these are not technical terms at Sungarden, but simply used to express our reaction to recent market events).
As one of our clients told us at our recent Market Research Event in New Jersey, they consider us to be "watch-aholics." It is true that we consider many, many factors (including the MTI) in our ongoing portfolio process, positioning and security selection at any point in time. However, some of the more interesting ones to us, are those which take on a very human quality. They are behaviors we observe which seem unjustified to us as straight shooters, but they exist anyway. And if they play out as they have in the past, we and our clients will be very happy we did observe them. Here are a few we think you may find entertaining...unless they describe you.
- Belief that the stock market's success over the past five years is due primarily to factors other than "quantitative easing (QE) / suppressing of interest rates" by the U.S. Fed and other central banks around the globe. Pundits point to strong corporate earnings, alleged recovery in the job market, low inflation, and American energy renaissance, blah, blah, blah. To us, these are all by-products of years of QE. Those by-products are unsustainable without QE. And, QE is ending. So....now we will see how investors that truly believe in all of that will fare when the proverbial tide of liquidity goes out.
- A Pavlovian response to stock market declines as a chance to "buy things on sale" without much fear that they are in fact trying to catch the proverbial falling knife with their own bare hands. Certainly there are opportunities in every decline and we have had only one real selloff of significance in the S&P 500 Index since early 2009 (an approximately 19% drop in late 2011). But, our suspicion is that many in the "buy the dip" crowd will justify their approach by saying that since it has worked for the past five years, it will work again and again. That's confusing bull market behavior with bear market behavior. To us, they are different. Like swimming in the Atlantic Ocean vs. the Dead Sea (I have done both...no comparison between them).
- Investor hubris returning to all-time highs reached in early 2000 and early 2007. This is our opinion, not something scientific. But through my column at Marketwatch.com and reading the banter in other Marketwatch columns between writers and readers, there is a steady drumbeat of over-confidence. Sometimes its the fans of "asset allocation" investment techniques feeling comfy that the bond market will always bail them out when the stock market falls (see the Sungarden Study at www.hedgedinvesting.com to learn why we think this is a fallacy). Other times, it is those who believe that if you don't plan to use the money for 20 or 30 years, active managers never succeed (also a fallacy, based on our other 2014 research study).
Regardless of the reason, everyone is entitled to their opinion. However, the bravado that accompanies some of these opinions, reminds us of some periods of time that later tuned out to be great times for skepticism that the stock market is stronger than the Fed allows it to be. We have our swim trunks firmly tied around our waists, and the life preserver is tied to our hand. If nothing else, this is a time to remember that investing is a balancing act, regardless of what appears to be happening around us.