Dr Stocks' Investment Strategy
Who would have dared, five years ago, at the abyss of the biggest financial crisis in decades, to predict that it would immediately be followed by an epic bull market? We are now standing - at or very near - all-time highs in many major markets. And there is only one decisive reason why this has happened: low, lower and lowest interest rates, the lowest since perhaps Napoleonic times.
This makes the current super bull unique. We are in the midst of an unprecedented monetary experiment - where prudent folks who save for rainy days or old age are severely punished, and debtors, bankrupt governments and wealthy investors reap monstrous benefits. I think most people would agree that this aberration can't go on forever. Every day is one day closer to a turning point; but we don't know when the "last exit" bell will finally ring.
And a "last exit" it might well be, because when interest rates eventually rise, this train will probably hurtle down a precipice. The markets seem to need crashes from time to time - just like volcanoes, where red hot lava is boiling under the surface. To sum it up: if you haven't been in the market until now, it's probably not a good idea to enter now. And if you are invested, you're a lucky fellow. Enjoy the ride and watch the weather very carefully.
As you might guess from the title of this column, it is the last Dr. Stocks column to be distributed to our friends.
Tempora mutantur, tempora labuntur. Times are changing, time is dwindling.
We hope that you enjoyed Dr. Stocks' messages and found them occasionally useful. Now it's time to say farewell and adieu!
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Markets are unstable, otherwise they couldn't be called markets.
Presently we're passing through some area of turbulence, but it is unlikely that we'll crash. At least not yet. While some unsettling omens have appeared, like the derailment of emerging markets and their currencies, we still have the lowest interest rates, at least in the major currencies. That won't change soon.
Published 4th quarter results have been okay, if not great. The future, however, looks rather overcast for many companies. Top-line growth (turnover) is barely visible. Cost cutting has run its course. China is uncertain. And it's getting much more difficult from here. It might mean nothing, but the last three times, when a new chairman of the US Fed came in, he was greeted with severe conditions shortly after accepting the scepter.
Now we have Mrs. Yellen, and she has to deal with a major - and potentially unnerving - transition: the ending of vast monthly purchases of US treasuries. In laymen's terms: limitless money printing times are soon over. And that's not good news for the drunkards who have enjoyed the overflowing punch bowl for a very long time. As Warren Buffet so memorably said: "When the tide goes out, one can see who has been swimming naked."
So, there are numerous warning signs, but all is not lost yet. My guess is, we are just experiencing a setback, and in a few days we'll have a bounce. That might be a good time to adjust one's exposure to the more volatile time we're facing. It's a good opportunity for swing traders. It also opens up some entry points to companies which one would like to have in the portfolio for the longer term.
Regarding gold: I don't expect a steep increase to old highs, but as always I recommend to keep some funds locked away in the metal in case the sky and the bottom fall out simultaneously.
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How Long Will This Be Going On?
Stock market history is a story of roller coaster rides, lethal dangers, missed opportunities and, occasionally, good luck. A look at only the last six years gives a perfect illustration of markets on the wild side: the Dow reached a peak of 14,198 in 2007, derailed subsequently and dropped by 54%, reversed course again in march 2009 and is now up by over 140% at 15,615.
If you slept through all of this, with your money squirreled away in an index fund, you're up 10%, after 6 years. Post fees you're about even.
Is this a fool's game?
Many readers would like to know at which point of the sinus curve we are now. One thing is clear: after a generational low four years ago, we are now enjoying a very strong bull market. The source of strength is clear: money is being supplied in great quantity, at interest rates we haven't seen in living memory. That makes this bull unique; it runs on a single, clearly visible monetary charge.
Obviously the biggest question in this context is: how long will the low interest rate environment last? Most observers ( we agree ) think we're safe for at least another 6 months. Some cynics claim we have to have low interest rates for a very, very long time because the fallout from much higher rates would be disastrous. Just consider budgets and sovereign debt: how would they look at interest rates of 5 or 7 %? As the example of Japan shows, extremely low rates can prevail for many years. Perhaps we in the West should also get used to such a situation. It suits the biggest debtors, governments, states and it silently cuts benefits for older people. It also enables a small class of wealthy people to buy first class assets with cheap credit.
That being said, one has to conclude that for the time being stocks are still a good place to be. There will be corrections and setbacks from time to time, providing good opportunities to trade a bit. Of course there are already some signs of irrational exuberance, especially in the tech sector and the so-called story stocks. Look at Amazon, for example: definitely an incredible success story with a correspondingly high price. But AMZN has not had a profit since its foundation, 20 years ago. Sure, profits might be just around the corner, but 20 years is an awfully long time to get out of the red - and pay a dividend. And there are plenty of such stocks which trade higher and higher on a good story (echoes of 1999?).
Despite some warning signals it looks as if the positive groundswell could continue a while longer. A Santa Claus rally perhaps? December and January are usually good months for the markets. The handover at the Fed, from Bernanke to Yellen, is adding some uncertainty. As mentioned above, be prepared for the occasional setback.
One last hint: what investment opportunities might the brouhaha about the borderless spying of the NSA (annual budget over 50 billion USD, twice as much as the Department of Agriculture) and others open up? Think enhanced internet security, safe cloud operators, encryption and spy detector ware....
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Summer Lull Ends
As expected not much has happened over summer. Most markets went sideways within defined trading ranges. Will the lull end soon?
We can see plenty of reasons for a downward push and ONE strong reason to stay up. The latter is obviously the stubborn insistence of central bankers to continue wrestling interest rates to the floor. The longer this manipulation of rates continues, the more asset prices become distorted. Massive bubbles in bonds, stocks and real estate have already developed. Pressures are building up, as in active volcanoes, or along the edges of tectonic plates, and when those pressures are suddenly released, massive earthquakes occur. The coming financial Krakatau will affect us all.
But nobody knows when this disaster is going to strike. It could be anytime, next month or in five years.
What should an investor do in the meantime? Sit and wait or, in Citicorp's Chuck Prince's famous last words "get up and dance as long as the music is playing"? It didn't end well for Mr. Prince, but he was at least allowed to carry 36 million with him on the way out . As the internet bubble showed, manias can last quite a while longer than one would expect.
Therefore, we recommend to stash away a substantial amount in cash and safe short term investments, and keep the rest in the game. The next few weeks will be quite interesting, with the power play between President Obama and the Tea Party lunatics coming to a head. But by November, we should have reached calmer waters again, and we can probably use the turmoil to buy (back) some slightly cheapened stocks.
Not among those would be certain stocks running on speed and fumes which are presently in high fashion. Tesla, Priceline, Netflix etc. are some examples, giving off an echo of past excesses. Again, as experience shows, such excesses can go on for surprisingly long periods, and it would be very dangerous to bet against the must-have highfliers. Investment managers have to prove that they are on top of developments and need to show such sparklers among their holdings.
On the Euro front we don't expect bad surprises. The result of the German election and some upbeat signals from countries like Spain leave us with a slightly positive attitude.
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A Time to Act
A bit more Caution perhaps?
Equity markets have done well so far this year, with the S&P 500 up about 18%. They look close to fully valued now. There is substantial downside risk if - and when - the easy money blasts from the Fed and its cousins ever end. In fact, the perception that times are changing could create a nasty little panic. There are certain echoes of 1987, when rising rates and a bit of automated trading (it was called portfolio insurance then) caused a painful setback. Rising long-term rates, high-frequency trading and an algorithm gone bad could derail the gravy train. Our QE grandmaster, Mr. Ben Bernanke, has reached the last lap of his performance, and, while certainly not interested in rocking the boat on his way out, is a diminishing force. His talked-about successors, Janet Yellen or Larry Summers, might be undergoing a test like Alan Greenspan in (again) 1987.
Bull markets usually end with a final exalted stretch up to a narrow plateau. The Nasdaq has just reached a 12-year high.
It's possible that the markets go up a bit further; many people have been afraid of all kinds of real and imagined troubles and have thus missed the recent upswing completely. There is still money on the sidelines. However, it seems to us like a time to be slightly more cautious. Perhaps one should reduce the stakes a bit as we'll probably enter a more volatile stretch. More volatility means more trading opportunities. To catch them, it helps to be alert and active. Experience could trump aggressiveness for a while.
For the longer term, we are still optimistic. As we don't see a strong economic recovery anywhere in the world, we assume that monetary conditions will remain benevolent. There would be bankruptcy hailstorms everywhere if interest rates would suddenly jump much higher. We've all become addicted to cheap money, from hopelessly indebted states to house buyers and consumers. A withdrawal of this drug would give us the shakes. And yet, as everything, this too will end. Whenever that happens, and it could be a while till then, gold will shine. In the meantime commodities and their producers (BHP Billiton, Rio Tinto, Glencore etc.) are in the dog house - and could remain there for an extended period of time. But keep an eye on them; the day will come when they'll return outrageous profits again. This day, however, is not yet near. Patience is required.
As to our favorite sector, US banks, we take some profits, keep a bit in the game and try to surf the waves.
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A Time to Act
Markets had a good run recently - but few have profited. Tons of money are still piled up at the sidelines - or stuck in low-yielding bonds. Many institutional investors, insurance companies etc. have less than 5% invested in equities. It hurts to watch prices float up and away. But markets are volatile and corrections happen ever so often.
We'd use such corrections to get into the market - or back into the market. We see good trading opportunities coming up. Why?
The fundamental bull case is still intact. Bernanke and friends are holding interest rates low, and liquidity high. That won't change much, because business is lackluster, China is slowing down, commodities are weak, jobless rates remain high. Nothing much will change over a short period of time.
But off and on somebody will cry wolf, scaring the crowd with the coming end of QE. Now, sooner or later, QE must end - and will end. But we think it will be later. Thus we see opportunities, whenever a little panic befalls the herd.
As mentioned many times over the last year, we think opportunities are excellent in US financial shares. The good times are not over yet, and we'd use short, sharp setbacks to gobble up more of that stuff.
We remain cool towards commodities and precious metals, not expecting much from those sectors. However, we still believe that a certain amount should be kept in gold, preferably in its physical form, as an insurance for unexpected bad times and surprises. Gold doesn't pay interest, but it has many advantages. Think about it.
To sum it up: use current opportunities to buy stocks, preferably in the USA. It doesn't help to ponder endlessly, bother clueless advisers and live in fear of unimaginable catastrophes. Just shut up and take the money!
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Timing the Market
Trying to time the market is a fool's errand; that's what practically all investment advisors agree on. But when the crash of october 1987 happened, I thought: if only I wouldn't be involved in just one such big crash and could thus get in immediately after it, I'd be lightyears ahead.
Now, it's really very difficult to get one's timing right, but I believe that it's not totally hopeless to make an effort. First, one would need long experience to various markets to have lived through various cycles, booms, euphorias and crashes. The latter come along like a thunderbolt or they can last tortuous years. Secondly, one needs to fill the information tank to the max, reading papers, blogs, company reports and so on. Folks who work in normal day jobs and pursue their careers don't have the time to do all that. Professional advisors would perhaps have the time, but many are too busy with their errands and too lazy to read tons of stuff to be of much use.
Of course, one could just follow some simple rules, e.g. don't jump in when the papers and your neighbours start talking about the market in an overly excited tone. Anyway, if market timing is possible, it's certainly not easy. That brings us to the current situation: many popular indices have reached new highs or are in the vicinity of them, the NASDAQ being one notable exception.
Is this a time to get OUT, if one has been IN at all?
The one big pillar of market strength has been the mass of liquidity provided by central banks. It looks as if it will stand a while longer. Political events (elections in Italy, sequester in the US etc.) are usually short-term disturbances and don't need to worry us too much. Companies have been doing generally very well and have accumulated piles of cash. Profits are ok if not fantastic. Trillions are still piled up in bonds, yielding next to nothing. What's the problem?
There could always be unforeseen events like a sudden war, crisis or terrorist attack. But instead of getting out of the market in fear of uncertain and unforeseeable events, it's better to keep some catastrophe insurance, e.g. cash and gold. For now I think it's quite ok to ride the trend up. Not all boats are being lifted though; selectivity is still necessary. In my last missive I've recommended US banks. They have done quite well and I stay with them for now. One of my favorites, as mentioned before, is Citicorp.
Sooner or later the good news will end, and we'll see a sizeable correction. I think we're not there yet. When it gets more difficult to raise any enthusiasm for particular stocks (a tired bull) we should start to sell. But in not too much of a hurry because history teaches us that certain trends extend their lives due to the entrance of Johnny-come-latelys and slow moving big funds.
Enjoy the ride while it lasts!
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