In Agreement

A few strategists whose opinion I value seem to be in agreement that the market is due for a rest but not a major top. Last night I posted a video of Tom Demark, who has made some pretty good against the grain calls in the past year.  He is looking for a 5% correction but not a collapse. In his latest weekly missive Jeff Saut takes a similar stance saying that he is cautious but not bearish. He says he could see a 5% correction or he could see a sideways correction but he does not see a complete collapse. Tony Dwyer of Collins Stewart is looking for a 4% correction before a larger 10% gain.

My view is similar to these strategists in that I too believe that we are unlikely to collapse but are likely to correct somewhat. There are imbalances out there and any one can creep up at anytime so I am not writing off the possibility of a bigger decline, but I don't believe one is imminent. Depending on one's time frame this can be taken in different ways. I would like to avoid a 5% decline if I could and am being more aggressive about hedging and cutting market exposure. I do consider the longer term which is why I have been reluctant to go net short. Additionally, I believe that the  market is roughly fairly valued at current levels. To an investor with a longer time horizon a 5% correction might not matter.

I would grow more bullish on the market if we did get some sort of a correction. If we traded sideways through the middle of March I would likely take some long trading positions for the seasonally strong late March to mid-April period. At current levels I believe that one risks a 5% correction and the outside possibility of a systemic event.

3 comments:

Shubh Desai said...

I am in agreement with you as well. I think in short term we
can have 5 to 7% correction.


But I am long term high dividend investor. What scares me is
some perma bear predicting some nasty fall in next few years. They are talking
about taking away most of the 90’s gain.


I don’t believe in that but it stays in back of my mind.


I don’t like to sell my holding. I like to collect rising
dividend year after year. I rather hedge then sell my holdings.


What are your thoughts on those bear calling nasty fall by
2016?

frank r said...

@shubh:disqus: The probability of a massive bear market is almost certain at some point in the next 5 years or so, as deflation transitions to inflation. The Fed, as a bureaucratic institution, will take the path of least controversy, which is to fight the inflation by raising interest rates and reversing all the QE. But this will not stop the inflation, because there will still be a structural budget deficit, which will be aggravated by higher interest costs. So Congress will have to either cut spending sharply and raise taxes, or else tolerate the inflation. I suspect the former, with much of the hike in taxes directed at the investor class. Elimination of the lower rate on capital gains, higher rates on ordinary income, mandates on corporations (for health insurance, etc) that effectively act as corporate taxes. Bottom line is that stock yields will have to go up substantially to account for the higher taxes (so that the after-tax yield stays the same), which means stock prices must fall. And stock prices will have to fall some more to account for higher real interest rates on bonds. Finally, corporate margins are very high now, but there should be some mean reversion at some point due to competition and new supply. Putting all this together, I think it's reasonable to plan for stock prices to fall 40% in real terms from today's value (to about 800 on the SP500 in today's dollars, higher in future dollars). Given the reduction in earnings from mean-reverted margins and higher corporate taxes and other factors, PE's won't be screamingly good at the bottom as if earnings didn't fall, but they will still be very attractive, so it will be a very good buying opportunity.

There is really no way to avoid the coming massive bear market in stocks and long bonds. If you go cash now, you earn nothing between now and the cataclysm. If you go stocks or long bonds now, you get some yield now but then take a capital loss later. Gold is impossible to predict, though higher real rates should be very bad for something that doesn't have any yield. Higher real rates will also be bad for real-estate, which is still suffering from the bubble aftermath. On the other hand, real-estate in some areas (like Sacramento) is cheap enough now that it should do very well once the deflation turns to inflation. If you buy Sacramento real-estate as a landlord, using a 30 year fixed mortgage, and plan to hold indefinitely, then your return will likely be excellent over the next 20 years, at least compared to buying stocks, bonds, or cash right now and holding through the crash without trading.

The other possibility is to deftly trade the markets, taking advantage of swings from greed to fear and back again to pick up some yield for now, while planning to be all cash when the crash begins. Needless to say, that is difficult.

Tsachy Mishal said...

There are a lot of imbalances out there and its certainly possible that another disaster occurs in the next few years. I keep this in the back of my mind but I don't let it paralyze my near term thinking. The market has more than doubled since the low in 2009 and focusing solely on these long term imbalances would have stopped one from participating.

I try to buy businesses that are  not too highly levered to the economy or financially, so that I could make it through such a period. Hopefully there will be warning signs if we were to enter such a period.