Beyond The Headlines

The bull market crashed. Now what?

Too many contradictory opinions, too little sense.

February 13, 2018 | Diandra Ramsammy
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What happened?

Over the last few days, we have seen about a 10% correction in major equity indices around the world. It definitely got everyone’s attention. Globally, estimated $5 trillion of paper wealth vanished in a matter of days. What happened though? No war, no impeachment, no lasting U.S. government shutdown either.

An upbeat job report allegedly sparked fears of inflation, and quicker interest rate hikes. Why would that matter though? After a decade long recovery, supposedly booming economy, record low unemployment, record long accommodative monetary policy finally wages tick up. Why panic? Is it even a lasting spike in wages, or maybe oil price swings and natural disaster recovery activity have something to do with it, and if so it will be a short-lived spike anyway.

Staying disciplined

Our goal is never to beat the market or any specific index in any period of time, our goal is to preserve and grow wealth over the long-term. As much as we always enjoy the treasure hunt for new bargains, we hate taking big losses.

For a while now, we’ve been watching the markets carefully and with a healthy dose of caution and skepticism (We Take A Careful Look At Our Cautious, Contrarian Stand – August 1st, 2017).

Given our disciplined contrarian investment approach, we’ve been seeing more reasons to trim our increasingly overvalued positions than to add new ones. If the market doesn’t offer any truly compelling investment opportunities, we choose not to alter our discipline and shop for lesser opportunities just because they happen to be less overvalued than the market as a whole.

As a consequence, our investment strategy led to record high cash levels in our portfolios. Those, on the other hand, triggered some really good questions. “As a stock picker shouldn’t you be finding opportunities in all the markets?” – was one of many that came up.

Holding cash is an investment decision

Our advice remained unchanged  (The Most Unusual Bull Market – September 26, 2017) – it’s an overvalued, overhyped, overinflated market with underwhelming fundamentals, and record leverage only possible thanks to record low-interest rates. If we can’t find what we like, we are happy to sit it out, and patiently hold on to high cash reserves. We think and invest in terms of decades not few month windows.

Fiscal and monetary debacle

The Fed has been raising rates gradually, and supposedly remains committed to continue on that path. It’s also shrinking its balance sheet, which could create an interesting dynamic when faced with an insatiable appetite for more government spending, thus more new borrowing. Who will buy Treasuries if the Fed is selling? And why the record spending if the economy is in the 9th or 10th year of expansion? Will the Fed stay committed to its prior direction given the new Fed chairman?

Unfortunately, still, the near-term market performance remains in the hands of monetary policy rather than the fundamentals. It’s a very difficult balancing act for the new Fed chairman. (More on the subject in my earlier article: The Emperor’s New Clothes – Understanding Today’s Financial World – June 23rd, 2017)

Simple but not easy

Setting the market free to establish the cost of borrowing would diminish the role of the Fed and all central banks. This would trigger a possible storm in the financial markets, but likely set a stage for a healthier financial world in the future with less distorted capital allocation.

Maybe it’s a revolutionary idea today, but so was the end of the centrally planned economies in the Soviet-controlled Europe until 1990, and that worked out very well lifting many from poverty, realizing full potential of those nations, and building vibrant economies. Yours truly had the pleasure of witnessing the process in person. The transition wasn’t pretty, and the term of shock therapy was coined.

I am hopeful that the right time for the end of the centrally planned monetary policy will come in my lifetimes as well, but that could be a long-time away or not? In the meantime,… 

Is there a safe place to hide?

If anything, the last week’s crash (correction, blip, hiccup – you pick the label you like) proved to be a peculiar sell-off, where not the high-flying tech stocks led the market lower but the Dow Industrial Average, and overall “value” stocks, and dividend stocks fell more than the growth darlings of the last few years. Investors are still holding onto their hot winners hoping that they remain immune in this sell-off. That may change quickly, when the market realizes how much growth has already been priced into those stocks.

What’s ahead?

We see many completely contradictory narratives attempting to make sense out of the dramatic sell-offs and the pick-up in volatility. We worry less about volatility today and in general. Volatility is the necessary ingredient of the price discovery process, and that’s what this market is trying to do. What worries us more is the extent of price and value disconnect that remains in the current equity and bond markets (both still close to all-time highs), and the unprecedented mispricing of risk.

Those that pay attention could see that it took few days for the high yield bond index to give back all the post-election gains, and it would take another 25-30% decline in the major equity indices just to get back to the election night.

What to do?

We don’t subscribe to the school of thought that you have to be 100% invested at all times not to miss out on the last melt-up of a tired aging bull market. When the market valuation is at an extreme high or low, 0% invested or 100% respectively might be a theoretically ideal place, but it’s a wide range, and everyone needs to find their own comfort zone.

We don’t claim to know exactly when the bottom or top of the market or any security price is. What has worked for us is the gradual approach. Slowly building, and slowly cutting exposure and positions.

We’d rather be imperfectly right than perfectly wrong.

Bogumil Baranowski




This article is not intended to be a clientspecific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.