Introduction
Many
years ago when people actually held each other there a very energetic fast
dance called the “two step” which exhausted the dancers and often at the end
left them clinging to each other. I am wondering whether there is a reasonable
chance that we are setting up a “two step” dance before we have the “big one,”
a once in a generation major decline.
A
Contrarian View of Current Sentiment
A
basic belief derived from history is that the only attribute that market
survivors share is a well earned sense of humility. A study of history through
the ages, cultures, and fields of endeavor shows that at critical points most
people are wrong, but not always. Viewing the current stock market through that
lens raises the possibility that we can be on the edge of a meaningful market
advance.
A
number of good market analysts pay more attention to sentiments and shifts in
sentiments than economic and financial ratios. There are a number of sentiment
readings, some published in Barron’s
each week. One that has caught my eye is the weekly readings from the American
Association of Individual Investors which also parallels my sense of
institutional investors thinking as indicated by changes in transaction volume.
In the last three weeks the percentage of bullish individuals has dropped from
34.2% to 25.0% with only a minor increase in neutral views going from 33.0% to
35.1% with a major rise in the bearish column from 32.8% to 39.9%. One can
understand that the current political and military events are matters of
concern, but in theory investors should have longer term time horizons than day
traders. Both my study of history in general and the learned analysis from the
racetrack, suggests to me that the odds, not the certainty, is that the
dramatic switch in sentiment is wrong.
Interesting
to me is that market volume has not picked up. This indicates to me that while
people are generally worried about conditions they are not now acting to preserve
their wealth or that of their clients.
Stock
Market Analysis
What
is more interesting to me, particularly as an investor in some smaller cap
funds, is that the NASDAQ index has gone to a new high. The older and broader
indices both in the US and a number of other markets are in striking range of
new highs. While the NASDAQ index did hit a new high on a light volume Friday,
it did not go up to qualify as a clean breakout of a past trading range and
could reverse and create a top. Recognizing I am intrigued with the possibility
that the index will achieve a breakout velocity.
The
tactical importance of a breakout, particularly if followed by others, is that
the prior reversal patterns, called “head and shoulders” becomes a base for a
material advance. The base will show a rather large volume of past sellers who
may feel the need to get back into the market to participate in future gains.
Often the past sellers left large relatively high quality stocks and now may
feel the need to quickly catch up through more than normal (for them)
speculative investing.
Thus
a vigorous “two step” dance could be in our future.
Fears
of “The Big One”
One
way I attempt to keep up with investing globally is when possible to read
English language foreign media both for their local and global views. Recently
I read an article in The Star
Online from Malaysia where Tan Sri Andrew Sheng who writes on
global issues from an Asian perspective. While enjoying the 24.7% gain in the
MSCI Emerging Market Index, he is concerned that we may be heading for a major
drop. In this light he as we all should re-read Charles Kindleberger’s “Mania,
Panics and Crashes” (Macmillan, 1996). He identifies the following steps to the
collapse labeled the South Sea Company Bubble of 1720:
- Displacement
- Credit/ Monetary Expansion
- Over Trading
- Financial Distress
- Fraud, Swindles, and Malfeasance
- Revulsion, mistrust of shady products and intermediaries
- Panic selling
We
have seen similar risks attached to a number of other panics before and after
the South Sea Company Bubble panic. His bullish view is that he does not see
enough similarities to today’s markets to fear
a repeat panic.
The
odds are that he is correct that the next decline will be one of the more normal
falls. In the US context when we had floor specialists and other well
capitalized broker/dealer trading desks this meant declines in and around 25%,
not the once in a generation collapse of 50%.
However,
as the job of a prudent analyst is to think the impossible thoughts. I look at
the above itinerary to panic and feel we may be on a similar somewhat predictive
path. One might suggest that either the internet or bitcoin qualifies as
displacement. The key concern with displacement is that it is an excuse at
least temporarily in believing old rules of prudence no longer apply. The
growing lists of unicorn valuations for private companies that have little or
no profits but with perceived great futures. It makes me nervous that some very
good mutual funds are currently profitably benefiting from their private equity
investments. Some less sound funds may follow and could have liquidity
problems.
Our
friendly central banks and deficit spending by governments and the growing number
of new credit funds are certainly expanding money supply to the market systems.
The mere hint of a “tapper” can cause both bond and stock markets to shudder.
At
the moment most of the remaining sign points are not flashing great concern
which is why I have not built reserves up in our long-term oriented mutual fund
managed accounts. However, I am very concerned about the item of revulsion and
mistrust of intermediaries. Some in the media are perfectly looking to shout
“fire” in a crowded space. In addition, numerous politicians may act against
all the intermediaries and their favored products. Their math is not based on
dollars or other currencies, but on numbers of potential swing votes. As a
critical element of self protection those of us who are professionals in the
market need to have our clients and their beneficiaries understand that while
we undoubtedly make mistakes, we are essentially honest and place them ahead of
our own short-term financial interests.
It
is a mistake to rest our relationships primarily on performance, particularly
short-term performance.
With
appropriate level of concern and caution I am still a believer that the process
of prudent investing can generate longer lasting wealth than most activities,
as long as it is based on our best efforts.
Momentary
Input
On
an intermittent rainy Sunday on the Labor Day weekend, the crowd at one of the
glitzy shopping malls, The Mall at Short Hills, crowds approached the Christmas
season levels. The big difference that I noted is that more men were in
attendance, not just as bag carriers. They were actually shopping and often not
in the company of female companions. At numerous stores there was a major
effort to divert credit card sales to their home or co-sponsored brands.
Retailers are also looking to capture long-term relations not just current
sales. This is a necessary effort, hopefully it is not too late to keep any of
the stores open for business in the malls.
Question:
How quickly will your humility permit you to reverse some of your investment
choices?
__________
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A. Michael Lipper, CFA
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