“Jonathan has advised us for 5 years and always provided consistent, truly independent thinking with emphasis on capital preservation”

Tim Bacon (CEO, Colville Estate) and Marylyn Bacon (Kent) (2011)

Paraphrasing the Bible: The market moves in mysterious ways

Posted by jdavis on September 27, 2010

Dear Client

The following is a round up of my thoughts on the stock markets. If any of it is at all unclear, as ever, please do contact me for clarification.


The huge stock market rally started in March 2009 with an S&P 500 value of 666. We started locking in growth from 2009, by selling stock market-related holdings when the market was around 1080, in October 2009, we sold more in January at slightly higher prices, and we completed our selling in July when the market was around 1080 again.

It is now around 1150 and it has recently been down to around 1010/1040. In other words, it is just a few percent higher from when we sold, and has been a few percent lower.

I remind you the major markets have a very high correlation to the S&P.   So, the FTSE is almost identical. The S&P 500 has been up and down and again since this time last year.   We are currently where we were in January ie the market is unchanged since 8 months ago, net.

There are those who say that we will rise further to breach the April high.  They may be right but I do not see it that way.

ALWAYS there is mania at highs and depression at lows. It was ever thus. There are many articles and TV talking heads put out to entice people to buy at this point. Well, I ask you. With the global economy in the state it is in, AFTER the market has risen 70% since March 2009, what would make YOU buy?

We try to BUY LOW AND SELL HIGH.

As far as I can tell, there is NOTHING holding this market up other than central bank (ie Federal Reserve of US) and major participants’ (Goldmans Sachs, JP Morgan et al) short term manipulations.

I find the following instructive:

  • The September run up from 1040 to 1145 has been on much lighter volume of transactions than during the falls in 2007 to early 2009 and after April 2010 ie there is little actual enthusiasm behind the rise (and, incidentally, just like last year’s house price rise in the South East – on very low volumes). NB. On the chart, change to 5y (5 years) to see how volumes were much larger for the crash and at April 2010 and how volumes fell consistently during the market rise of 2009… indicating that last year’s rise may be entirely unsustainable.
  • The Investors’ Index of optimism is at extreme highs, even higher than before the start of the almighty crash which started in October 2007 (ie investors generally get it wrong, as a whole)
  • The percentage of cash held in mutual funds is at an ALL TIME LOW ie fund managers are as fully invested as they have been in 50 YEARS, thus they are at maximum optimism (how many of them forecasted the crash of 2007 to 2009 or the global housing and commercial property crash (or Dot Com less than a decade ago, or the Wall St crash of 1929 to 1932 etc etc)?
  • The banks are barely lending either on mortgages or to small and medium-sized enterprises.
  • The global government bond yields are at extreme lows ie the bond market believes we are in or heading for Depression. The bond market is rarely wrong. They called the bottom of the stock market (end 2008 / early 2009) brilliantly.
  • The global economy is in meltdown. I have written about this often enough so I shan’t repeat it again here.
  • Finally: The index of financial companies in the US (banks, insurance etc).   You may recall I wrote the following in June: “On the stock markets…[the case against Goldman Sachs…].   This will weigh heavily on GS, banks and the market for a long time to come.”

Even though the wider market has peaked higher in September, the financial stocks – the largest component of the wider market – continues to have a slight downward tendency over the year (see the gentle slope from top left to bottom right in peaks and troughs, equally, except the (potential?) outlier April). The wider market cannot rise sustainably without the financials supporting. They are not doing that.

So, what do I make of it all? Exactly the same as I have done for around 4 years. This market is ill. Just like the 1930s. As for our clients’ positioning – they are generally neutral with a small short bias. I am quite happy with this, at these high price levels.

Taking a medium term consideration – which is what we do here, I remain of the view that the markets are in downtrend which started in October 2007. (After a 70% rise, the market is still 25% down on the October 2007 high). No trend goes in a straight line. Otherwise it would be called a straight line. (NB. Our clients are UP 15-30% since October 2007.)

We have had a decade of an orgy of debt and spend. Now we have the biggest economic hangover in history. I do not ‘make the economics’. I merely interpret them on your behalf.

Can the market rise further? Of course.

However, as I have previously discussed with you, I work in the world of probabilities ie of what is more likely to happen.  I ask myself, is it more likely the market will rise and rise than it will fall?  I do not believe so.  I believe, the greater probability is to the downside.   That is how our portfolios are positioned.  Should you wish to discuss this with me personally, as ever, just pick up the phone or send me an email.

What would change my view is falling unemployment, rising bank lending, governments getting out of financial trouble and rising bond yields, to name but a few of my watch list criteria.
 

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