In April of 2018, I wrote an article discussing the 10-reasons the bull market had ended.
“The backdrop of the market currently is vastly different than it was during the ‘taper tantrum’ in 2015-2016, or during the corrections following the end of QE1 and QE2. In those previous cases, the Federal Reserve was directly injecting liquidity and managing expectations of long-term accommodative support. Valuations had been through a fairly significant reversion, and expectations had been extinguished. None of that support exists currently.”
It mostly fell on “deaf ears” as the market rallied back to highs. Since then, the market has continued to “cling” to a “wall of worries” as noted in Tuesday’s missive by Doug Kass:
The reason I said “cling,” rather than “climb,” a “Wall of Worries” is that over the last 22-months the market really has not made much progress. With the market only marginally higher than it was in January of 2018, it has been mostly the ability for investors to withstand a heightened level of volatility.
The following is a WEEKLY chart of the S&P 500 as compared to its 4-year (200-week) moving average.
Here is the same chart on a MONTHLY basis as compared to its 5-year moving average.
Note the extremely long time frames of the underlying moving averages. We will revisit these in a moment.
For investors, it is important to understand the “bulls” maintain control of the market narrative for the moment, and, as noted last week, the “bullish wish list” was fulfilled over the last several weeks. To wit:
If you are a bull, what is there not to love?
This is a critical point. Given the fact we are now moving into the “seasonally strong” period of the year, the “bulls” clearly have the advantage, for now.
This is why we continue to maintain a long-equity bias in our portfolios currently. We also recently slightly reduced our hedges, along with some of our more defensive positioning. We are still maintaining slightly higher than normal levels of cash.
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“So, IF the “bulls” do indeed have control of the market, then why are allocations still somewhat hedged for risk?”
The simple reason we still remain cautious is due to several reasons:
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.
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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A Conservative Strategy For Long-Term Investors
There are 4-steps to allocation changes based on 25% reduction increments. As noted in the chart above a 100% allocation level is equal to 60% stocks. I never advocate being 100% out of the market as it is far too difficult to reverse course when the market changes from a negative to a positive trend. Emotions keep us from taking the correct action.
Please read the main body of the newsletter this week.
Given the “bulls” have the upper-hand heading into the end of the year, we will likely increase our portfolio exposures over the next couple of weeks once we get a handle on how the markets are going to react to all of the news.
In the meantime, you can prepare for the next moves by taking some actions if you haven’t already.
If you need help after reading the alert; do not hesitate to contact me.
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