In the short run, the market has been flip-flopping in a relatively narrow trading range since the beginning of 2010. After plunging in 2008 and roaring back in 2009, the market has climbed slowly but steadily except when interrupted by ham-handed bumbling by politicians here and abroad. But for the recurring fears of a Eurodollar crisis spreading to the U.S., the market would have been a dreary backwater for most of the past 2 ½ years.
Only consumer cyclical stocks, buoyed by a recovery in auto sales and a stabilization in the construction sector, have performed particularly well during this period. The U.S. consumers’ ability to keep on spending ought to make the Energizer bunny envious. On the down side, the heavily regulated and government subsidized financial sector failed to participate in the rebound. Otherwise, nearly all U.S. stock sectors have participated, at least to some degree, in the slightly improving trend in stock prices since 2010.
Stepping back for additional perspective, the flip-flopping that began in 1998 has even deeper roots. The twentieth century ended with a bubble in the tech sector, rather than a bang as Y2K fearmongers imagined, and 1999’s rampant greed resulted in unrealistic expectations about what the overpriced equity markets could deliver in the decade to come. Now, more than fourteen years later, valuations are lower, the froth has been wrung out, and expectations have come down to the point where stock investors, those that remain, have nearly lost hope altogether. Trading volume is down. Market rallies are sapped by fearful headlines. Companies are afraid to invest and hire. Those young people lucky enough to have jobs show little interest in accumulating equities.
Warren Buffett famously reminded his shareholders to, “be fearful when others are greedy, and be greedy when others are fearful.” My contrarian radar is picking up the sort of antipathy toward stocks that ought to make an investor drool.
Unfortunately, the fundamentals continue to disappoint. Our May-Investments Leading Economic Indicator has turned down a bit. Corporate profit margins are too high, primarily as a result of unsustainably low borrowing costs. Europe is in a recession. Even a recession in China seems like a possibility. Employment in the U.S. has been anemic for more than a decade. Private sector economic growth has been anemic for nearly three decades. What growth we’ve had, for most of my working career, has come from the ever expanding government sector, both at the local and national levels. Now that our national balance sheet is starting to look like Greece, our ability to keep expanding the size of government has been hindered but the still lackluster private sector hasn’t been able to fill the gap.
Until we begin to fix the private sector, we will probably continue to be buffeted back and forth between the forces of government inflation and private deflation. Until we begin to address the core problem facing the U.S. private sector, this flip-flopping gag-inducing trading range may continue. Maybe the stock market will rise in nominal (before inflation) terms, but in real (after-inflation) terms it probably isn’t going anywhere. Equities and real estate may be the best games in town, because bond investors and cash equivalents will likely be losing value when adjusted for inflation, but until we start taking our medicine and addressing the problems that have prohibited private sector job growth for over three decades, I fear the flip-flopping blip-chopping drip-hopping rip-topping madness will continue.
Negotiating this politically driven market has been difficult, and we do not claim to have been particularly successful. We used to readjust portfolios monthly in order to take advantage of long-term trends in various asset classes. In 2008, when things began to fall apart, we began trading intra-month and by the end of that year we were tracking markets on a day-to-day basis. More recently, we have had to adjust our clocks once again and many days have been forced to track trends on an hourly basis. Literally, we come in to the office unsure of whether we ought to buy into the recent uptrend or keep our stash of money on the side, waiting for lower prices and a better time to buy.
This makes it nearly impossible to write a blog post worth reading. Should I write about the U.S. economic indicators that are falling, suggesting that the U.S. economy is about to fall into recession? If I write about that, what will people think if I end up buying back into the market at the end of the day?
Or should I write about the enormous upside that stocks offer at current levels, given the healthy return on invested capital at current prices, and the potential for future appreciation offered particularly in light of low returns elsewhere. When the gloom and doom fades away, buying stocks at today’s prices will be a smart move. However, it’s not clear that, a month from now, we won’t have an even better opportunity. We are investing on a moment-by-moment basis, rather than on secular growth trends in favored asset classes, trying to get in the way of what’s working but often getting whipsawed because today’s mini-rallies have the half-life of a fruit fly.
The portfolios have a lot of cash on the side ready to reinvest and the technical signals are trending back up and close to signaling that it is time to buy back in. We are prepared to follow the discipline, with this caveat. My best guess is that this is yet another head fake. If we do buy back in and the markets turn down, it might be just a matter of a few days (or even hours) before the technicals go negative once more, suggesting the downtrend is re-emerging. If this happens, we would likely sell immediately, and put the money back on the sidelines.
It is not our wish to be day-trading the stock market. We would much rather have a Congress focused on boosting employment rather than partisanship, a President focused on getting America working again rather than on the next election, and a market signaling positive trends rather than flip-flopping in a narrow trading range. While we wait for markets to return to health, we will continue to follow the flexible Beta discipline that we have established to manage risk in this high risk environment.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .
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