In an effort to provide some additional color on how RMHI is approaching the first three quarters of 2010:
- 2008 and 2009 were trend years. This means the trend in place at the beginning of the year was a trend that stayed in place all year long. We do not expect 2010 to be a “trend” year. 2004 is a good example of this as we were in the second calendar year of an economic rebound and the stock market tread sideways for the bulk of the year.
- We do not believe there will be a large prolonged move to the upside or the downside this year as we saw in ’09 and ’08. Hence, selling dries up quickly after a sell-off and rallies exhaust themselves just as easily. A good environment to “buy the dips and sell the rips”.
- Extremely unlikely to see an economic or financial market collapse despite the headlines. The issues in Greece and Dubai are essentially aftershocks to the big quake in 2008. If you sell out on such headline news you’ll likely regret it quickly.
- The boring sideways range should not a long term affair. More likely a doldrum lasting months not years, similar to 2004.
- Considering how we’re positioned, a sharp sell-off would be very welcome.
Be careful out there
Brad
2010
A year ago, markets and economies were largely in chaos mired in the worst selling since 1932. However, since that time world central banks have initiated massive monetary stimulation and markets have, for the most part returned to normal. Thanks to the monetary stimulus we’ve experienced the birth of cyclical stock market rally since the March bottom within the larger context of a bear market.
Tom Dorsey, a stock market technical analyst commonly refers to his posture in the stock market with football metaphors. When Tom states that it’s time for the “Offense to be on the field” it means it’s time to get aggressive in the stock market, inversely Tom will state “the Defense is on the field” when it’s time to pare back holdings and, well……..be defensive.
In 2008, the Defense should have been on the field the whole year and the opposite was true in 2009 where Offense won the game and then some. It’s my belief that 2010 will be a year where both Offense and Defense will be required at one time or another to prosper. Consider it a year with not a great deal of net yardage but a saw-tooth environment in a cloud of dust and little net gain.
In 2009 markets followed the script I laid out with great accuracy but this year should not have quite the peaks and valleys and volatility should be lower. January 2010 found complacency amongst investors was the norm with almost uniform belief that the short term was good and our long term prospects horrid. I took the opposite tact and was willing to miss some upside potential to be in position for a market pullback. By January 19th I had jettisoned most of our high flyers and raised cash to the highest levels in almost a year or purchased Inverse Exchange Traded Funds for the first time since early ’09.
I do not believe this current market weakness is the start of a new major bear market. Credit spreads have come to their narrowest margin since the fall of 2007 which is indicative of future economic growth in the U.S. The current sell-off is being driven by Europe and Emerging markets of which U.S. appears to be collateral damage. The credit issues that have affected Greece, Dubai, Portugal, Spain and Ireland are significant to the extent that “this time it is different” and notions of smooth and uninterrupted expansion from Recession are not to be trusted. Does this mean we’ll revisit the 2009 market lows? Very unlikely, but it could mean a prolonged trading range which we’re currently geared for.
People might jump to the conclusion that as an investment manager my highest ideal is to provide a stellar return in a good year as was the case in 2009, but for me that’s really not the case at all. My ideal is to provide a good rate of return in flat to down year. That’s what I’m striving for since the start of the year since I believe 2010 will frustrate both inflexible bulls and bears alike by bouncing along a trading range with 1030 on the downside and 1150 on the upside. In the trading range I expect, market exposure will have to be culled at the top of the range (the defense takes the field) in an effort to reduce the downside on pullbacks, while increasing exposure (the offense takes over) at the bottom of the range when fear is rampant. This is the strategy in place at present.
The contrast between 2009 and 2010 are significant enough to warrant a cautious position.
- Cyclical bull markets within the context of a secular bear market have a mean of 17 months and a median of 12 months. At present, we’re at month 11.
- Post Recession Blues: The odds of at least a 10% market correction in the S&P 500 six to eighteen months into an expansion are 77%. While corporate earnings should be quite good, typically the stock market doesn’t respond as the earnings were discounted the year before.
- Stocks are no longer cheap: The median valuation of the S&P 500 is 22 as of this January. This compares with a 40 year average median of 16 and a low of 12 set this past March. On a “GAAP” real basis US equities are valued at level comparable to 2000 and 2007.
- Too much love: Investor sentiment was as dismal (which is good!) as I’ve ever seen this past March to the point where I had to wonder why I was the only one bidding on shares of China Automotive at $4. Last month, investors couldn’t get enough at $20. Our own models went to such a frothy extreme January 19, 2010 that we initiated our first hedge trade to protect portfolio values since early ’09.
To summarize my thoughts on the coming year: I believe 2010 will be a sideways trend year with perhaps 1150 or so the top side of the range and 1030 on the downside, an extended period of digestion and frustration for bulls and bears alike. This saw-tooth trading range would be fairly normal considering the run in ’09 and in keeping with past trends in the second year of an economic expansion. The range could be broken to the upside in the 4th Q of 2010. My best guess is that a breakout will require at least minimal inflation and no meaningful spike in interest rates. Adding to the potential breakout in the 4th Q will be the return of October weakness which could create a high degree of negative sentiment to enable a strong rally. In the meantime in the February-March time frame we could see a market bottom leading to a decent market rally. The current pullback has been extraordinarily swift with resulting sharp rise is fear and loathing….a very good thing. But this expected February-March rally will likely be short in duration and could peak by April.
Gold: It’s my view that Gold is in a long term bull market and has been for several years. However a few months ago we cashed out of our holding which turned to be within a few days of the peak. Since that time Gold has pulled back approximately 14% and investor sentiment has turned extremely pessimistic. It would appear that the present time would be opportunistic to reallocate to Gold. Adding to the opportunity created by significant negative sentiment is that the “Real Yield” (adjusted for inflation) on T-Bills is negative. Historically when the “Real Yield” is negative as was the case in the mid to late 1970’s, the return on Gold has been very good. In addition, if the Federal Reserve extends its quantitative easing or we see another stimulus package this could ignite another serious rally.
Short Term: Accounts have either hedges against long positions or have their equity allocations in cash as we’re in a neutral position for the time being. Typically, when we see extremes in enthusiasm or pessimism and swing of the pendulum in the opposite direction looms ahead. There has been a significant reversal of over exuberant investor sentiment since January 19th but not enough to warrant a more bullish investment stance at this time. If bad news beckons and the markets make another leg down our potential losses should be muffled by our hedge positions and hopefully sentiment will become extreme enough (pessimism) to take a bullish market stance. This could lead to a pretty good month of March and April.
For short term updates please visit the RMHI blog at: www.greeninvestment.com/blog. On an unrelated note, for many years I’ve been involved in the rescue and providing homes for Great Pyrenees and especially Akbash dogs at our ranch here in the high Rockies. We’ve decided to perpetuate this purpose by naming the ranch “The White Dog” since we’re always being asking “Are you the guys with the white dogs?” Pyr’s and the Akbash have special needs and require a great deal of land to patrol and protect and it just so happens the ranch is perfectly suited for them, including the very long Winters. The white dog pictured on our home page at www.greeninvestment.com is our first male Akbash rescue we renamed “Vasi” which is Turkish for “great”, and he is all of that.
All the best,
Brad Pappas
President, RMHI
Just over two weeks ago our sentiment and valuation indicators moved into an extreme zone associated with high probability of a market pullback. Investors were poorly positioned and increasing complacent to the point where any bad news would cause a reversal in the herd mentality.
Now we have markets in full retreat based on macro concerns with Greece, Portugal, Spain and China. It has been 11 months since we had a market selloff that created enough fear to create the necessary fear to set up a significant market rally, it appears thats coming to an end.
I’d like to see the S&P 500 break through support at 1070 which will likely lead to another leg down to the 1030 area. In the meantime any bounces might best be served to add to hedges rather than taking on new long positions. Too soon to go long in my opinion but the pullback is creating a new series of opportunities for us. I’m estimating that this pullback could take us down to the 200 day moving average on the S&P 500 which is approximately 1020.
We continue to hold very high cash positions or hedges in the form of Inverse Market ETF’s.
Be careful out there
Brad
Last week we covered our hedges a few days too early as the selling continued faster and farther than I had anticipated. While equities are moving up approximately 1% this afternoon, I have added a new round of hedges as I suspect this bounce is temporary.
The trading action over the past two weeks has been very different from anything witnessed after the March low. There is no longer the fear of missing a train leaving the station, plus we have a strong move in gold today that could be negative harbinger in the Middle East.
And while my indicators are no longer stretched to extreme levels as they were two weeks ago, we have yet to see any climactic selling and that has me worried. We’ve only seen relatively mild selling thus far and typically a good market bottom is put into place by fear and forced selling.
Regarding gold, we have finally added a new round of buys into the metal as a double bottom may be in place. The U.S. dollar has had a nice run at the expense of the metal and if the dollar runs out of gas, or if people start getting trigger happy in the Middle East, gold will be of relative value to us.
Be Careful Out There
Brad
Long Gold
Its only human to change investment opinions on recent market actions. Our emotions can change from day to day and from tick to tick. However, basing your decisions on loving a market more as it moves higher or loving it less as it declines will eventually prove to be very hazardous to your investment health.
I tend to like a market less and less as it rises and appreciate it more as it declines, hard lessons learned. We raised a great deal of cash for clients two weeks ago as sentiment indicators had moved to an extreme….extreme love and affection for stocks. From out of the blue China raises interest rates and our President initiates a populist attack on our largest banks. With most market participants fully invested, their next move could only be to sell which they’ve done with vigor.
Now, markets have come down and sentiment has cooled considerably. This means its time to pull out my yellow pad and develop a list of potential additions to portfolios. Gold is looking increasingly more attractive down here as well.
Having a significant amount of cash on the sidelines changes your state of mind enormously in a pullback. Market sell-offs are not something to be entirely loathed as you don’t feel quite so humbled. Sell-offs now become a window for opportunity as we cheer for fear and loathing to return to set us up for the inevitable rally.
Be careful out there,
Brad
Long Gold
Sifting through data this morning was the equivalent of a triple shot of espresso: Too much love for stocks.
Rallies and gains have a foundation of fear and loathing, not love. Too much love is a rally killer. Its not easy to throw beloved CAGC and ZSTN back into the market but now our primary mode must be to protect capital and gains.
Adding a second leg to our Ultra Short Hedges.
Selling off our TBT with a small gain. Any selloff appears to be due to weak economic data and not rising rates, hence the TBT’s are weak this morning.
Be careful out there
Long but reducing CAGC, ZSTN, TBT
