Written by Lance Roberts, Clarity Financial
“So, IF the “bulls” do indeed have control of the market, then why are allocations still somewhat hedged for risk?”
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Great question.
The simple reason we still remain cautious is due to several reasons:
- Despite the “bullish case” suggesting higher prices into the end of the year, there is still a not-insignificant possibility of failure.
- Even with the “bullish backdrop,” the markets have, at least for now, been unable to make, and sustain, new highs. (see chart)
- The is a high level of complacency among speculators (see chart)
- CEO confidence in economic expectations has fallen sharply to levels which have denoted lower market returns in the past (see chart)
The chart below is the S&P 500 as compared to its 5-year MONTHLY, moving average. With the market currently pushing one of the highest deviations from the long-term average, investors would do well to remember that “reversions to the mean” occur with regularity.
As is always the case, historically speaking, the “bull case” ALWAYS appears to be “correct,” until it isn’t.
Unfortunately, for most investors, by the time they realize that something has going wrong, and they find out just how much “risk” they have layered into their portfolios, it is often too late to do much about it.
This is why “risk management” is always vastly more important than chasing returns.
What To Watch Out For
The one thing about long-term trending bull markets is that they cover up investment mistakes. Overpaying for value, taking on too much risk, leverage, etc. are all things that investors inherently know will have negative outcomes. However, during a bull market, those mistakes are “forgiven” as prices inherently rise. The longer they rise, the more mistakes that investors tend to make as they become assured they are “smarter than the market.”
Eventually, a bear market reveals those mistakes in the most brutal of fashions.
It is often said the religion is found in “foxholes.” It is also found in bear markets where investors begin to “pray” for relief.
Many investors have dismissed the lessons they learned in 2008. There are many more who have never actually seen a “bear market,” and understandably believe the current bull cycle will last indefinitely.
I can assure you it won’t, and “experience” is always a brutal teacher.
As I wrote in “The Exit Problem” last December:
“My job is to participate in the markets while keeping a measured approach to capital preservation. Since it is considered ‘bearish’ to point out the potential ‘risks’ which could lead to rapid capital destruction; then I guess you can call me a ‘bear.’
Just make sure you understand I am still in ‘theater,’ I am just moving much closer to the ‘exit.’”
After having trimmed out some of our gains in our equity holdings throughout the year, and having been a steady buyer of bonds (despite consistent calls for higher rates), we are well positioned to take advantage of a rally to new highs if it occurs.
The cash we hold also protects us against a sudden sharp decline.
For the bulls, it’s now or never to make a final stand.
Just remember, getting back to even is not the same as growing wealth.
If you need help or have questions, we are always glad to help. Just email me.
See you next week.
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