The Bull/Bear Conundrum----An Update On Where It Now Stands

 In March of this year, I wrote an article entitled "Think Like A Bear, Invest Like A Bull" in which I discussed the importance of not letting personal emotional biases derail your investment strategy and discipline. To wit:

"The 'Hussman Effect' is where investment decisions based solely on fundamental analysis can lead to poor outcomes when other dynamics take charge.

Like Hussman, I too am a value-oriented investor and prefer to buy assets when they are fundamentally cheap based on several factors including price to sales, free cash flow yield and high return on equity. However, being a strict value investor can eventually lead to a variety of investment mistakes, which I will discuss momentarily, when markets become both highly correlated and driven by speculative excess.

Currently, there is little value available to investors in the market today as prices have been driven higher by repeated Central Bank interventions and artificially suppressed interest rates. Eventually, the markets will begin a mean reversion process of some magnitude which will suppress the price of highly inflated 'value' stocks that have been driven higher by investor's 'yield chase.'

However, when that reversion process occurs is anyone's guess.

Therefore, while the analysis suggests that portfolios should be heavily underweighted 'risk,' having done so would have led to substantial underperformance and subsequent career risk.

This is why a good portion of my investment management philosophy is focused on the control of 'risk' in portfolio allocation models through the lens of relative strength and momentum analysis.

The effect of momentum is arguably one of the most pervasive forces in the financial markets. Throughout history, there are episodes where markets rise, or fall, further and faster than logic would dictate. However, this is the effect of the psychological, or behavioral, forces at work as 'greed' and 'fear' overtake logical analysis."

This idea of viewing the markets through a "bearish" lens to identify potential risks to portfolio capital while remaining "bullishly" invested in the financial markets has never been more prevalent than today.

As witnessed by an article I was sent yesterday, there are certainly more than enough reasons for investors to sharply reducing equity risk exposure. To wit:

"'Time is now rapidly running out,' warns The Telegraph's John Ficenec as the British paper takes a deep dive into the dark realities behind the mainstream media headlines continued faith in central planning. Ficenec warns that from China to Brazil, the central banks have lost control and at the same time the global economy is grinding to a halt. It is only a matter of time before stock markets collapse under the weight of their lofty expectations and record valuations."

He cites 8-primary fundamental concerns:

  1. China slowdown
  2. Commodity collapse
  3. Resource sector credit crisis
  4. Emerging markets
  5. Credit markets
  6. Interest rate shock
  7. Length of current bull market
  8. Valuations

To that list, I can add several technical concerns as well:

  1. Extreme deviations from long-term moving averages
  2. Deterioration in market breadth
  3. Slowing momentum
  4. Shrinking leadership
  5. Declining relative strength
  6. Multiple non-confirmations
  7. Long term sell-signals registered

Several of these issues were captured in the following chart (updated through yesterday's close) that I posted in "A Sellable Rally:"

SP500-Technical-081815-2

However, despite the fundamental and technical backdrop that currently exists, the market has not violated its bullish trajectory to date. This is due to the "fear of missing out" as recent experience has taught investors not to bet against the global Central Bank cabal. Regardless of the economic or fundamental backdrop, declines in price to the long-term bullish trend have repeatedly been met with Federal Reserve assurances and a "buying panic."

SP500-Technical-081815

This is the "Bull-Bear Conundrum" in action.

As I have discussed many times in the past (most recently here), we are NOT "investors" but rather "savers" who are speculating that markets will rise over a given time frame.

Currently, the bullish trend remains intact, as shown above, which keeps portfolios fully allocated. While this certainly seems counter-intuitive given the deterioration in the fundamental and technical underpinnings, the markets have a nasty habit of "remaining illogical" far longer than most expect. 

For advisors, the danger of exiting the markets too soon is potential career risk. While an exit today may indeed turn out to be the right call eventually, an advisor may have lost a bulk of their clients in the interim.

However, some of this "career risk" can be mitigated by applying prudent portfolio management practices. Such practices can keep portfolios allocated to the markets while reducing some of potential volatility risk. This allows an advisor to "react" to changes in market trends when they occur on a logical, rather than emotional, driven basis. Furthermore, these practices align with the most basic investment rules/philosophies that have been followed by every great investor/trader in history.

  • Sell positions that simply are not working. If they are not working in a strongly rising market, they will hurt you more when the market falls. Investment Rule: Cut losers short.
  • Trim winning positions back to original portfolio weightings. This allows you to harvest profits but remain invested in positions that are working. Investment Rule: Let winners run.
  • Retain cash raised from sales for opportunities to purchase investments later at a better price. Investment Rule: Sell High, Buy Low

There is no magic formula for long-term investment success. It has always been achieved by following simple processes and disciplines that have managed investment risk thereby reducing emotionally driven decisions during times of increased volatility.

The current bull trend WILL NOT last forever. However, it CAN last far longer than most imagine. What will be the catalyst that sends the bulls running for cover? No one knows. This is the problem with trying to "predict" the markets. As repeated studies have shown, humans are terrible forecasters. Instead, dispose of this idea of being "bullish" or "bearish" and focus on the "risk" you are undertaking within your portfolio.

It is only when the markets take a turn for the worse that investors realize the meaning of "risk."

Our job is NOT to try and "beat" some random benchmark index. Investing is not a "competition" that you "win" a trophy for. Investing is about growing your "savings" to sustain the purchases power parity of those "savings" in the future. Nothing more. Nothing less.

David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

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