Head Fakes are Great in Basketball
But, you really have to be leery of them in investing.
The market rally last Friday and coming into today may be giving weary investors some hope but I think it’s more of a bear market trap more than anything.
There are complex technical descriptions of this type of trap and I won’t bore you with any of them, mainly because I think they are nonsense, but also because I love simple explanations. The simple explanation of this type of trap is when markets get to or enter a bear market, there is a short period where markets will typically rally and try and get out of that dreaded place. Many times it’s just investors believing a bottom has been reached and they want to time it. Bad idea. It also may be a trigger point for certain investment vehicles to reenter the market so that liquidity increases and forms a base and these same instruments will need to reallocate funds back into equities. That increased liquidity invariably dries up unless some other market participants start reinvesting as well. Be that, Sovereign wealth funds, multiple institutional players or rarely, government intervention.
While Sovereign wealth funds have an excess amount of capital, I am not so sure they will add on to already extensive US equity positions at this level. Remember, we are on the cusp of a new investment environment. Higher interest rates, slower growth, possible recession. Not the best time to put your cash hoard to work I would say. With potential negative returns from here to the end of the year, why not keep those billions in Treasuries until the time is right?
Institutional money managers now are scrambling. Their returns for the first time in over a decade are going to look bad. Doesn’t matter if they were beating their benchmark by 50 basis points, their funds are down and the holders of those funds are scared. Without thinking longer term, bigger picture, many investors are liquidating funds. Generally however. when the retail investor liquidates, it is time to buy but I have a sense that they might be spot on.
My reasoning is this: Investors who thought they were the second coming of Steve Cohen are now realizing that they are not and their cost of living has gone up substantially. The money they might have allocated for investments may now be used to maintain equilibrium. Maybe they are looking at their statements and realizing, unlike last year, they are losing. They earn more, but everything costs more. They were up 28% last year and flying high and now they are coming back to earth. Human psychology is a very strong thing and that psychology is changing rapidly. Along with the talk of a potential recession, what you are seeing is a shift in investment philosophy.
This shift is what I believe will impact markets and the economy for the next year or so. Consumer sentiment is softening but that is not unexpected. The depth of that change might be and thats what you want to look for. Another thing to look for is housing indicators. New home sales, new permits, mortgage rates, average prices and so on. This is the real true indicator of the health of the US economy.
I have said this numerous times and I will say it again, if there is a protracted change in housing, that is as accurate a macro indicator as you will find. No recession has ever started with rising home sales. Again, psychology will play an important part of this as well. If Americans are negative about their economic future, they will not take on the added burden of home ownership. One other more complex factor is that with the boon in construction over the last five years, is there even a need for the same continued level of building? The population of this country is not growing by 6 or 8% yearly. Why is the supply of housing growing at that pace? The population is aging and the amount of people entering the “home buying years” is shrinking. Get my point?
Getting back to my original point, why does anyone think this is a buying opportunity and where do I think the market is going?
Looking at this technically, I will still maintain that around 3800 on the S&P is a support level. The number is a bit arbitrary I will admit but it’s just a guy feeling and some technicians would say otherwise but let’s just go with that for the time being. If the S&P breaks through that level with any emphasis, there is the potential for a move down to the 3517 level (which technicians will agree on) and that my friends will be a true bear market. The length and severity of this bear move will be discussed at that time but if we do break through support at 3800 (give or take 40 pts) we will see markets work their way to the next support level. It won’t be pretty and consumer sentiment will dry up and that projected 2% rise in the GDP for the second half of the year will not be met.
As an investor, it will be scary and you may want to join the fumbling herd and sell at points but your original philosophy of making investments at specific times and looking at the long game should stay in place. Inflation, recession, stagflation, deflation. They have all happened before and we are still upright. Bigger picture investing is hard but the most successful investors have one thing we all should work towards, they are disciplined. Be disciplined!
I have felt for a long time that equity markets were overpriced, I still do. This bear market pullback has helped bring prices closer to where they should be. This is not just relative P/E’s but the bigger longer term picture for companies. What will there business models be like with higher interest rates, slower growth, etc. It’s probably more complex than that but what I am trying to say is that we are going to enter a period (and by some measures we are in it) of slower growth and the very real possibility of a recession. In no time in human history has the stock market risen when a recession is in the conversation. How can it? Earnings growth will slow so valuations should change and readjust to the new environment. That’s what we are experiencing now. Where does it stop? When does the market start valuing new growth? Honestly, I don’t know. What I do know is that we are not there now and that is why this is a “Bear Market Trap”.