Many a man curses the rain that falls upon his head, and knows not that it brings abundance to drive away the hunger.
~ Saint Basil
Update: This post was included in the Carnival of Financial Planning – Edition #146. Thank you!
Today we’ll try to answer the last four questions posed by Kevin at Out of Your Rut in his article on where the stock market is headed. (You can read my answers to the first four questions in Part I.) Before we get started, I just want to mention that there has been quite a bit of bearish commentary lately, and it’s not just coming from yours truly, David Rosenberg, and other recently bearish analysts. If you don’t follow me on twitter @BalanceJunkie, here are just a couple of articles that caught my eye on Tuesday, both courtesy of Zero Hedge:
- BMO Has a Simple Message to Its Clients: Go to Cash Now: This article refers to a recent note from the Bank of Montreal’s Quantitative/Technical desk. In it, they recommend that clients go to a 0% equity weighting (yes, you read that right) in light of the way credit market deterioration is progressing. Equity markets haven’t priced in this deterioration yet. Bear in mind that this advice is most likely directed at more sophisticated and active DIY investors.
- Bearish Trio Complete: Albert Edwards Chimes In: “We Have Not Seen the Worst Yet”: This article is a nice 3 for 1 from Zero Hedge. It summarizes the bearish case as presented by 3 different strategists, at least one of which is a former permabull. This is well worth a few minutes of your time.
Now let’s take a crack at questions 5 through 8:
5. Which Sectors Will Outperform & Which Will Underperform?
In order to answer this question, I should first explain that I think this crisis may have two phases to it. I’m not sure at all how long each would last. Phase I will be a deflationary environment brought about by excessive global debt levels. During this period of time, I would prefer not to own any stocks or bonds, but if I had to choose some sectors that might do well, I would pick utilities, consumer staples, bonds and possibly gold.
Still, the idea that some sectors might lose less money than others doesn’t appeal to me. As a result, GICs and savings accounts will house my cash. If you are the trading type, you may want to consider inverse ETFs.
Phase II will be inflationary (possibly even hyperinflationary or stagflationary) with global central banks having printed tons of money to try to ease their debt burdens. There will be a race to the bottom in terms of currency devaluation. The survival of the Euro is a question mark.
I’m not sure how this type of environment would affect specific sectors, but I suspect you could reverse your trades from Phase I and do OK. Bonds would likely get clobbered as interest rates rose. Utilities, staples and other “safe” investments may fall as higher interest rates from risk-free savings accounts compete for money that would normally flow into dividend-paying stocks.
Commodities and stocks can perform well during inflationary environments, although I’ve seen just as many studies that show they could be hurt during these times as well, since inflation is not kind to consumers’ wallets. I’m not really certain how all of this will play out. These are my current theories, and I caution that they are only theories.
6. Do You Think the 21st Century’s Crash #3 Is Imminent?
The short answer to this question is yes. I do believe we will see another crash sooner rather than later, but I don’t know if it’s imminent or not. I’m writing this on Tuesday afternoon and for all I know, it may happen before I even get to post this on Thursday morning. Or it may not happen for a while yet. I don’t know. What I do know is that the current state of affairs is unsustainable. As a result, I don’t care to invest any of our money in it at the moment.
7. If You Believe the Markets Are Heading Down In a Major Way, Where Should We Be Putting Our Money Right Now?
Cash is the safest investment. If you have a very long time horizon (more than 20 years), you could maintain a small equity position, and gradually build on it on major dips. This market has the potential to go down for the count for quite some time, so I don’t want to get caught up in the idea that it always bounces back. Sometimes it doesn’t.
I have a theory that the S&P 500 and the TSX may follow the pattern of the Nikkei over the past 20 years. I’ve linked to this chart a couple of times already, so I do apologize to those who have already seen it. I can’t say for sure that we’ll be even or down from current levels in 20 years, but that chart reminds me that it’s a possibility. The current fundamentals increase the odds of it happening.
8. Are Stock Market Crashes the New Normal?
Kevin notes that we’ve already had two stock market crashes in only 10 years – the Nasdaq crash of 2000 and the subprime crash of 2008. I think that we will continue to have these crashes until our fiscal and monetary authorities let one of them do the work they’re designed to do: clear up unsuccessful, unproductive consumers and companies. Once governments and central banks stop rescuing failed businesses and individuals, capitalism can work again.
I have a feeling that the authorities may have no choice but to let the next crash play itself out, as most of them have essentially run out of bullets. Market forces may be insurmountable in the end, even for the U.S. Federal Reserve. We will eventually have to take our medicine. It will taste horrible, but we will finally be able to begin the healing process once that occurs. Wouldn’t it be nice to invest in companies with good fundamentals again rather than wondering if macroeconomic forces are ready to torpedo even the strongest balance sheets?
One of the difficulties inherent in the two-phase progression I’ve proposed is that your investment strategy would be completely different for each phase. As such, catching the transition from Phase I to Phase II relatively early will be instrumental to your investment success.
These are my current thoughts on the markets. I am by no means pounding the table on the scenario I’ve laid out here. I’m just thinking out loud and answering some key questions to the best of my ability. Thanks again to Kevin for getting this discussion started!
What are your thoughts on these questions? Are there any bulls out there? I wouldn’t mind hearing some opposing views as well.
The only thing I do know is that, historically, the more bear forecasters there are, the better the odds of making money in stocks over the following decade. Forecasters are historically brutal, as an aggregate.
When people are generally bearish, and ready to give up, the markets are poised for growth.
When people are bullish and happy that markets have been moving, the investment horizon ahead tends to be bleak.
What was that famous Barron’s cover in 1974? “The Death of Equities”
Bears….line up and keep growling. The more you growl, the more I’ll buy.
Greedy in Singapore,
Andrew
Andrew Hallam´s latest post ..Money Managers Who Make Sense
Greedy in Singapore: I love your confidence! I think we will have a Barron’s moment at some point. I just don’t think we’re there yet. Thanks for your comments!
My mistake. It was Newsweek 1979, not Barrons 1974. Gosh, this stuff is tough, even looking back.
Andrew Hallam´s latest post ..Money Managers Who Make Sense
No problem Andrew. Your point is still well-taken.
[...] in on Thursday for Part II of this article and my answers to the next 4 questions in Kevin’s [...]
2 cents – Your analysis in Part II is even better than in Part I. I asked questions, you’ve provided the insight.
A few days after I posted the original article, Marc Faber gave a speech in New York adressing largely the same questions–2 cents I hope you don’t mind that I’m including link below, but this is a real eye opener.
Some of the more interesting things he said…a sovereign debt collapse is inevitable in the Western countries…stocks will likely be better performers than bonds and treasuries…best places to put your money now are stocks in emerging economies, land in emerging economies and gold. The emphasis on emerging economies is because he says the shift of capital and power to these areas is real and the future of the West isn’t good (too much debt, not enough production).
My take is that I agree with what he says is happening, but I think things can hold together a lot longer than any of us think, so I’m not sure his advice will be of benefit in the short run at least.
Anyway, very interesting podcast if you don’t scare easily!
http://www.youtube.com/watch?v=H0sS6a9RW2E&feature=player_embedded
Kevin@OutOfYourRut´s latest post ..Consider an Online Degree For a Change of Career
Thanks for linking to the video Kevin. I actually started watching it via the Barry Ritholtz Big Picture blog earlier this week. Finishing it is a must this weekend. I think you’re right about the Western collapse being quite a bit farther into the future. There will be a gradual power shift from West to East.
When the collapse does finally happen, we will likely be told again that no one saw it coming and that we are collectively victims of unforeseen economic forces. That wasn’t true in the last crisis and it won’t be true in the next one.
The point of discussing all of this is not to frighten people, but to raise awareness. If we can get our own financial houses in order by eliminating debt and increasing our savings, we’ll be in a great position to weather and maybe even profit from the coming economic shift.
Thanks again for kicking off this great discussion Kevin!
To play the devil’s advocate, my theory is that anyone thinking that there’s going to be a power shift from west to east hasn’t spent any time in the east. The east looks good on paper only–based on some of the things they might let you see and imagine. But it will take multiple generations for them to catch us on so many levels (it would be uncool of me to discuss those levels here) My theory is that they will never catch us. Before I moved East, I thought like most other western bound thinkers. But not now.
Andrew Hallam´s latest post ..What are You Doing to Make the World a Better Place?
Thanks for the first-hand account Andrew. I do think it will take multiple generations for this shift to occur, but I also think the U.S. will have a serious sovereign debt issue before that happens – unless they do something about their fiscal mess now.
I’m also not at all certain of how severe the West -East shift might be. But it seems like even a subtle change would have at least some economic influence.
If I’m not mistaken, Marc Faber himself is a Westerner who has transplanted himself in the East. I would love to read about your ideas on this West-East thing if you ever care to write about it.
A polite devil’s advocate is always welcome on this blog. We can’t really find truth or balance until we’ve looked everywhere first!
I can guarantee that NO ONE knows where the market will go. The future is unknowable. For every prognosticator who is right once there are 1000′s more who are wrong. That said, the best way to build wealth long term is a simple asset allocation of stock, bond, & real estate index funds with some cash thrown in as well. Rebalance according to your risk level, and over time, you will beat most active managers and other investors.
Barb Friedberg´s latest post ..The Secret to Cutting Your Debt IMMEDIATELY
No one can know the future. That’s true. But ANY investment that you undertake is an investment in the future. If you own stocks, you are long the economy and the markets. You are assuming that those investments will be higher in the future. If you own real estate, you are betting that property values will be higher in the future. If you own bonds, you are either holding until maturity to collect the coupon or you are invested in a bond fund, assuming that bond prices will be higher (and rates lower) in the future. Any of those scenarios may be true – OR NOT.
I could beat an active manager who is down 20% because I’m only down 10%. That’s not good enough for me. If I see a train coming, I get off the tracks. Right now, I see a train coming. I just don’t know the exact arrival time. Until then, cash suits me fine.
If the market happens to rally 20% from here, I’m fine with that. I haven’t lost anything. I think the odds are higher that it will fall by 20% or more. In the meantime, my money is safe in cash and I haven’t lost anything. There will be a time to invest more in stocks. It’s not now.
Obviously, you & I see things differently. As I always say, that’s what makes a market. Some readers will be more comfortable with your approach, and some with mine. History will judge which was the better strategy. I’m OK with being wrong. I’m not OK with losing capital.
All opinions are welcome here, so I hope you will visit again!
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