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The Right Question
As the market continues to make new highs the arguments about whether stocks can go higher or the rally will end become more interesting. As usual in any debate about the market, both sides can make a great case. There are a number of factors that I could point to that suggest stocks have room to run but there are also a number of troubling signs on the horizon that could stop the rally in its tracks. Investors almost always get drawn into this debate and most of the people I talk to are pessimistic that this rally can continue.
Professionals and individual investors always seem to want to know what the market is going to do, unfortunately that is the wrong question. There was a great article in the Wall Street Journal this morning that illustrates the folly of trying to predict the market. It quoted Doug Kass, a hedge fund manager who is almost always on CNBC, offering a mea culpa about being completely wrong about the market. In February he said he was as bearish as he has been in years in spite of the rally. Today he said “I rarely have been as mistaken as I have been thus far in 2013.”
The right questions are:
1. How are you invested based on what the market is actually doing? and,
2. How are you going to react to what the market is actually does?
Over the intermediate term the market is in an uptrend and over the short term the market is overbought. So, we are fully invested in our intermediate term models and holding cash in our shorter term models ready to put back to work on any weakness. If the rally continues we will continue to be fully invested in our intermediate term models and continue to buy into weakness and sell into strength in our short term models. If the rally ends then our intermediate term models will move to bonds or cash.
What is Really Going On?
One of the debates that I have been hearing is regarding fundamental factors— do market valuations and the economy give the market room to run or not? In the long run these things matter, but as John Maynard Keynes once said—”In the long run we are all dead”. What is really going on is quite simple, the Fed is manipulating the market to drive investors into stocks and of all the bad stuff out there nothing is scary enough to entice people to hold a 10 year Treasury at 2% when stocks are going up and yielding more. So right now investors are more interested in return on their capital than return of their capital.
Lessons From Gold and Apple
There were two interesting articles about gold this week in the Wall Street Journal—one about how its allure is starting to fade (no kidding) and another this morning about how the second largest college endowment fund, Texas and Texas A&M, lost $300mm on gold. Gold and Apple’s recent slides can teach investors a number of important lessons:
1. Parabolic Moves Almost Always Retrace—-Whenever an asset has a parabolic move up it almost always retraces most of that move at some point.
2. Investor Psychology Can Be Dangerous—Investors seem to believe that what has happened over the most recent past will continue. I once had an 80 year old investor tell me that she liked gold because it never goes down, even though she has lived through long periods of time when gold went down a lot. I am seeing the same problem now with bonds, investors believe they are safe because they have been for 30 years, but if/when interest rates go up then bonds will be anything but safe.
3. Diversification for Diversifications Sake Doesn’t Make Sense–Over the years many investors have become convinced that gold should be part of their portfolio, these investors are suffering now. Maybe it should, maybe it shouldn’t, but only when it is in an uptrend.
4. The Danger of Predictions–I was recently on Fox Business debating the owner of gold mining company who thinks gold will go to $5,000/oz within the next two years. Maybe it will, maybe it won’t, but where are your odds better–predicting the bottom in gold or buying stocks in an uptrend? I would argue that buying stocks in an uptrend is a better bet. Typically, once everyone believes something it never happens—Apple going to 1,000/share, gold going to $2,000/oz, etc.