We’re knocking on the door of September and already it sounds like there’s a party going on inside. Crunching the numbers this morning from St. Kilda in our new offices, we find the S&P ASX 200 has rallied 42.7% from the March 6th low. That’s a bit less than benchmark indexes in the States. But it is a nice, juicy, tradeable bounce.
So how much more bounce is there left in this market? That’s the question we grapple with today. If you’re into rhetorical fallacies, you might say we’re begging the question. You only assume it’s a bounce if you reckon the rally is not based on an improved long-term earnings out-look.
There are plenty of analysts and investors – many of whom are now filling up our inbox with snarky notes – that contend the worst of everything is over. It’s a recovery. And even if America is stuffed, Australia has its cosy China relationship to power commodities and the currency higher.
Maybe so, put probably not. We reckon it is a bounce in the image of the post 1929 stock market crash. You don’t liquidate a decade’s worth of speculation and leverage in 18 months. It takes years. They started the process in Japan in 1989…and it’s still going on.
But the stock market is not a television show or a graphic novel. It does not have a tidy beginning, an enthralling middle, and a miraculous end. Attention spans are short these days. People expect instant resolution. But the unwinding of a credit boom doesn’t work that way, especially when you have central banks and governments fighting it every step of the way with measures to prevent the needed liquidation.
Consider this our warning then: this rally is on borrowed time. We don’t know when. We don’t know why. But we do know what. And the what is that stocks are going to price in much lower earnings and investors are going to pay less for those earnings. Expect a lot of spring volatility.
Unlike late 2008, though, this is a great opportunity for traders, mainly because you can short financial stocks. The S&P ASX 200 Financial index is actually up 63.5% since the March six lows. We’ve been working with Swarm Trader Gabriel Andre to add short recommendations to his service. It’s ready to roll now, and Gabriel says the financials make inviting targets.
Energy investors ought to take heed as well. Lately there’s been a nice correlation between the oil price and stocks. The better the economy, the better it is for oil and earnings. Both have gone up.
We’re still bullish on energy for a lot of reasons. But if the party ends sometime in September/October/November, you can expect lower oil and energy prices. That means if you have gains in energy stocks, you’d want to think about trailing stops and profit taking. In fact look for profit taking on the share market as a precursor to a new move lower.
It certainly does make for a tricky investment strategy. Energy stocks are some of the few stock we’d really want to own for the next ten years. But stocks are stocks. And in a bear market, most stocks go down. So what do you do?
A more active management strategy is probably what’s called for. But this violates one of those old axioms of institutional investors: do not try and time the markets. The buy-and-hold strategy works when you’re in secular bull market. It also works to the extent that most investors take control of their investments in moments of extreme uncertainty. People end up selling at the bottom and buying at the top as a result.
So why become active when being passive is so much easier? Because your money – and perhaps your retirement – is what’s at stake. You can go along with the media and pretend the last two years haven’t happened, or that they did but everything is better. But remember, these are the people who didn’t see the whole thing coming in the first place. Does trusting them sound like a good game plan?
Of course most of the time, trusting the conventional wisdom/do nothing approach works. Most of the time the world’s financial system doesn’t totter on the brink of a cliff. Most of the time you wouldn’t have to bother reading about outliers, black swans, and worst-case scenarios – the subjects it is our full-time job to explore here in the Daily Reckoning.
But we reckon now IS one of those times. In fact, it’s been that way since the Fed took interest rates to zero in 2003 and kicked off a global liquidity boom in all asset markets. You live and invest in an era of global fiat money. How that era ends is a dead certainty. But when is another question altogether. More on that tomorrow.
for The Daily Reckoning Australia