Regular readers know that we have been and remain cautious about the current investment environment. Here are a few links summarizing this view over the last six weeks:
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Aside from valuation (and there has been some very reasonable debate around the notion that traditional valuation metrics may no longer be applicable to the stock market and economy we have now, read on the topic
here), U.S. stocks are still the most attractive of global equities on a relative basis. But that’s not saying much. And what comes next is unlikely to be a sanguine return environment for stocks (read the links above if you want a quick refresher of our investment world view). Does a nearly 2% rip in the S&P 500 yesterday (on no news) change my cautious view? Not one bit. If anything it strengthens it.
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I have learned one very important skill since my days as a short term trader in the late 1990s/early 2000s, and that’s patience. The notion that there are a lot of traders that consistently profit by predicting the direction of individual stocks on a day to day basis is untrue. There are plenty out there who try. But based on my own experience it either takes a certain set of skills (that very few possess) and/or a shit ton of resources (or knowledge that one should probably not possess :-).
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So patience means that you need to have a top down view of your investment environment, and confidence in your bottom up work on the stocks/etfs/funds that you use to express the broader view. The idea that one trading day can shake that broader view is silly.
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So it’s a matter of time horizon. The volatility in every asset class on the planet has now emerged on our shores. And it’s not a confluence of events to dismiss. And it’s unlikely to be tamed by the tools that left in central bankers’ hands. The bull market in global equities is over because the conditions that made it possible no longer exist, or are no longer effective. Sure you could have made this argument at nearly every pause in the SPX over the last five years when different iterations of QE came to and end. But there is one big difference this time. The only central bank whose QE actually worked is not even considering further easing. They’re considering tightening.
I think the S&P 500 will be down at least 20% from its May highs at some point in the coming months (possibly weeks). And I’m willing to be patient in that view. I won’t dismiss the rolling liquidation that started in commodities last year and has found its way to some of the best performing sectors in our stock market of late (Financials, Media & Biotech to name a few). I fully expect the selling that we just witnessed in these groups to find its way to other past leaders like consumer discretionary and high valuation/ high growth tech. Is this a healthy rotation? I think not. It seems like the end of an epic 6 year bull market.
That doesn’t mean a crash is coming. But it probably means the much different equity returns than we’ve become accustomed to. Those returns have averaged 15% a year since 2008’s decline of 38.5%. 2008 is the only year the SPX declined since 2002! If the SPX were to close the year near these levels, (down almost 7%) 2015 and 2008 would be the only two years the SPX went down since the end of the dotcom crash in 2002.
We seem overdue. Therefore, it makes sense to lighten up on equity exposure on rallies (like yesterday) and not be afraid of building a cash position.