The reaction to U.S. market’s capitulation resonated last week throughout the globe as, among others, Asian and European markets fell to their lowest levels in months. Clearly, the reactions reflected both fundamental weakness surrounding what is now becoming a global credit crunch, as well as a psychological desire to “get out of the way” of a falling boulder.
Suddenly, everyone is tracking the performance of equities.
While the crisis cannot yet be characterized as a stampede, it does have the makings for a free-for-all if the news worsens and if the effect is to take down the innocent as well as the guilty.
From my data measurement, the most sinister component we need to watch-out for is persistent negativity. As I have written previously, I saw early on the menace of “profits” built upon specious data, such as layoffs, price increases and leveraged borrowing. I expected the damage which has thus far come.
But it is more difficult to quantify the impact of mass selling and reverberating effects of a herd mentality upon valuations, trend lines, and volatility. This entire affair is unfolding against a backdrop devoid of stock buyers, low savings rates, poor earnings, inflation, and priorities so skewed from center that domestic politics has become an “either/or” proposition.
As is the case with most bear cycles, the whole matter can sometimes be blown out of proportion. Pundits go on television to tell us about “fast money” but are unprepared, methodologically, to address the normal parabolic course of investing. Just like the last great psychological and valuation bear (1999-2002), talking heads go blank when trying to find reasons not to hype the market.
Even the names of investments seem to glamorize the upside tendencies of equities: “hedge funds”, “derivatives”, “mortgage-backed”. Incredibly, investors flocked to risky transactions without “reading the fine print”.
As with all cycles, they can be measured for intensity and duration. Fortunately, I do not believe the data supports a long bear cycle, but keep in mind that this bull leg has persisted for nearly 5 years without a serious interruption. Although the net gain for 2007 has been wiped-out, the real asset class deterioration has been minor. Those sectors that led the macro expansion are still leading. Those which lagged, continue to do so. I have avoided overweighting (or even neutral-weighting) the Financial and Consumer Cyclical sectors for over one year, with just cause based upon their fundamentals.
While spreads between buyers and sellers widen, the emotional gap between “feeling safe” and “feeling unsure” widens, as well. Private wealth management requires perspective and perseverance. Further, it requires a complete understanding of one’s life risk/reward tolerances, and an acknowledgement that asset allocation investing involves patience for cycles. Lastly, it absolutely requires an understanding of the methodology one employs to aggregate wealth to the next level. The most disastrous combination is to put an aggressive investor with a conservative client.
Two things are occurring which I believe are changing the dynamic of my quantitative statistics. First, fewer buyers are entering the market (while so, too, is an increase in selling pressure). Secondly, bonds are losing luster as a suitable investment alternative to stocks, particularly against the backdrop of inflation and higher interest rates.
These data, along with the scenario I previously addressed (diminishing margins, price pressure, labor “efficiencies”, declining relative strength acceleration (RSI), and “backend” sector rotation away from Consumer Cyclicals) portends a period (45-days-3 months) during which relative and absolute equity performance should be quite muted.
Finally, I urge all investors to step back, take a deep breath, and widen the aperture of their objectivity. No one called the TV networks to say the market was “too high” in July. Similarly, recognizing that peaks and valleys are part of the process, don’t jump ship during the pullbacks.
Invest in what works, from a macro-economic perspective. Then relax and go play golf. It’ll all be fine tomorrow.
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