Jan

14

Consider that:

1. Sharp market downturns from highs are more often false positives than signs of impending meltdown.

2. Timing matters in making a market or economic prediction. If you miss a relief rally you miss the biggest gains. A relief rally is a stock rally from the foresight that fear, often of a recession, is abating.

3. Recessions do not always yield large, long term stock meltdowns. Big and long; pre- and post- recession meltdowns are not a given, just because that's what happened last recession. A paradoxical corollary: If most people think it will happen, it won't, it is already anticipated.

4. Wealth, if measured by real assets and growth of real assets (including human capital), makes the USA a very hard long term bet to beat.

5. Conspiracy and market manipulations are two-way streets. Just as stock market cheerleaders may have ulterior motives, so do the prophets of doom. Except, alarmists and media have a symbotic relationship. And journalists don't have worry about geting sued for causing you to worry too much. "Smart money" has a way of becoming "dumb money" when everybody is following the same guru and strategy. What are those strategies and who are the gurus?

6. The Fed's increasing money and Fed's decrease money may cause credit cycles but the Fed's diverting the normal flow destroys wealth. In a credit crisis few real assets are destroyed; only values are reassessed. Money, eventually, will flow to what is valued, not just what is safest, if the government does not divert that flow.

7. When you hear politicians talk of "change" the first thing you should ask is whether they are talking about downsizing or increasing government's power.

8. These topics will not be highlighted by the media.

Lon Evans asks:

Toe TagAre you possibly one of those who reassured the herd that the NASDAQ meltdown of 2001 was merely a “correction,” and that smart money would hold for the rebound? My opinion differs. This market is nowhere near its bottom.

I’m personally holding 1460-strike S&P 500 puts. I plan to ride them all the way down to 1200. With all the fraud and chicanery relative to the sub-prime mess, this is not the moment for optimism.

Russell Sears replies:

I did fine in 2001, but it may have been beginner's luck as this was my first year of running an S&P options portfolio, professionally. 2002 was not as good but OK.

I would agree that the market will get hit on those days where market senses “chicanery relative to the sub-prime mess” but we may disagree on how much of it is “fraud” and how much of it is uncertainty of the outcome, at least on the part of the banks. And note, the title was for all of 2008, not the next quarter.

Congrats on the 1460 puts. You sound like you did better than I in 2007. But I no longer run an options portfolio — perhaps this kept me out of too much trouble.

John White writes:

1 - Define sharp. -9.5% from 10/9/07 to 1/14/08 took three times longer than -9.4% from 7/19/07 to 8/15/07. Sharp upturns in a bear market are more often false positives than the start of the next bull market.

2 - Timing does matter, but how much depends on your investment horizon. Timing strategies differ significantly with investment objectives, e.g. retirement funding vs. meeting quarterly numbers on the trading desk at Golden Slacks vs. putting food on the table for your family every night. If you miss a bear market you miss most of the losses. A bear market is a re-pricing of equities from the foresight that growth in corporate profits will slow/go negative in the near term.

3 - Recessions never yield large long-term stock meltdowns, depending of course on your definition of large and long-term. Depressions do and I sincerely hope we never have enough depressions to develop a statistically significant correlation. One was plenty enough. A question for your corollary: Most people think the market will return an average annual compound growth rate of around 10% over the next 20 years. Does that mean it won’t happen?

4 - And? What’s your investment/trading horizon? Q1, 2008, 2028?

5 - Exactly why I’m responding with the “other side of the coin.” And anyone who listens to journalists for advice on trading or investing has already lost regardless of the bear or bull.

6 - Agreed with the added comment that the government often does divert the flow, the anticipation of the diversion can be profitable, and being oblivious to the diversion can be destructive.

7 - When you hear politicians talk, the first thing you should ask yourself is, “Are they a soggy #### sandwich, or just a #### sandwich?”

8 - The mainstream media are often a contrary indicator. By the time it is reported on the front page of non-financial publications, or parroted by talking heads on non-financial news shows, everyone always knows and a reversal is often around the corner.

Personally I think the S&P will have a greater return in ‘08 than it did in ‘07, but I thought I’d play devil’s advocate.


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7 Comments so far

  1. Jorge on January 15, 2008 3:07 am

    well, I’m not going to touch equities for a while following these arguments. They ususally come out just before markets start falling precipitously. The correction is welcome and 15/20% on the downside is nothing to worry about. The Chinese and Middle-Easterners will just step in and buy our companies on the cheap. It’s transfer of wealth time.

  2. steve leslie on January 15, 2008 7:44 am

    Your last point is very important with respect to the media and the pundits who show up on the financial shows. Vic and Laurel taught me that if it is already in the public domain it is largely useless information. I have a saying: "Those who are the least qualified are the most willing to offer advice."

  3. Craig Bowles on January 15, 2008 12:29 pm

    Is the U.S. really importing low inflation? China is installing price controls with inflation running at 6.5% in October, despite the renminbi (or yuan) gaining nearly 10% on the dollar. The govt says November CPI in the U.S. rose 4.3% from a year ago. The Clinton 1990 calculation of CPI is up 7.6% and the 1980 CPI is nearly up 12%. The average of the inflation calculations shows prices rising 8%. To think that Nixon was instituting price controls when inflation got to 4% and nobody is talking about anything but the slowing economy shows how much people have gotten used to inflation.
    The U.S. economy being inverted with our strongest index the lagging indicators is the largest inversion since the 1970s and Fed actions won’t change this problem.

  4. Lon Evans on January 15, 2008 6:08 pm

    Do I detect the odor of sour grapes? Ah well, I can take a little ribbing. After all I'm only up 30 handles
    towards the close. We'll talk again as the market approaches 1300. […] I've been bearish on this market since early summer.

    Oh well, we are, all of us, only human.

  5. Russell Sears on January 15, 2008 6:15 pm

    A little counting to clear-up the confusion.

    If you look at the S&P index for 6 month non overlapping periods going starting 12/31/2007 till 1983 (25 years not counting dividends), You will find it fell 6 consecutive non-overlapping 6 month periods starting in June of 2000.

    This is pretty amazing in itself, when you consider that the over that the negative 6 mnth. periods have 27% chance of occuring. But when you also consider that the only other back to back repeat was in one time in 1983. And the average for the next six month of the negative priors was + 4.4% not far from 4.7% of all the periods.

    I would also suggest page 2 section C of the Monday WSJ for a similar discussion. But I would extent it out to 12 months prior and after a recession to have to see the full effect of 2001 recession.

  6. gabe on January 15, 2008 10:47 pm

    what I’d like to know is where is mr gavekal with his advice that subprime is a non-issue? possibly seconded by Vic.
    ah, internet is a wonderful thing. it’s all in there with time stamps and the whole shebang for the posterity to see.

  7. Lon Evans on January 16, 2008 5:11 pm

    Well, That's another ten handles (ChaChing!). And thanks to the Subprime mess ("Subprime - What Subprime?") there's much more ChaChing to be had, and of course the numerologists are on the job. So go ahead, pull out your chicken bones and goat entrails. Keep us informed with your own particular ballyhoo. Eventually you'll get it right. After all, markets always turn, eventually. Take one side and you can't fail to be right, eventually. Until eventually, you might try grinding your teeth. I hear it offer tremendous benefit for those afflicted with hubris.

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