It has always been one of my pet peeves. The usual stock market cheerleaders start chanting into the echo chamber. Do they always believe that their efforts will create a genuine, consensus reality? A posting at the Daily Beast website by Zachary Karabell caught my attention. The headline said, “Bells Are Ringing! Confidence Rises as the Dow – Finally – Hits 13,000 Again”. After highlighting all of the exciting news, Mr. Karabell was thoughtful enough to mention the trepidation experienced by a good number of money managers, given all the potential risks out there. Nevertheless, the piece concluded with this thought:
The crises that have obsessed markets for the past years – debt and defaults, housing markets, Europe and Greece– are winding down. And markets are gearing up. Maybe it’s time to focus on that.
As luck would have it, my next stop was at the Pragmatic Capitalism blog, where I came across a clever essay by Lance Roberts, which had been cross-posted from his Streettalklive website. The title of the piece, “Media Headlines Will Lead You To Ruin”, jumped right out at me. Here’s how it began:
It’s quite amazing actually. Two weeks ago Barron’s ran the cover page of “Dow 15,000?. Over the weekend Alan Abelson ran a column titled “Everyone In The Pool”. Today, CNBC leads with “Dow 13,000 May Finally Lure Investors Back Into Stocks”. Unfortunately, for most investors, the headline is probably right. Investors, on the whole, have a tendency to do exactly the opposite of what they should do when it comes to investing – “Buy High and Sell Low.” The reality is that the emotions of greed and fear do more to cause investors to lose money in the market than being robbed at the point of a gun.
Take a look at the chart of the data from ICI who tracks flows of money into and out of mutual funds. When markets are correcting investors panic and sell out of stocks with the majority of the selling occurring near the lows of the market. As the markets rally investors continue to sell as they disbelieve the rally intially and are just happy to be getting some of their money back. However, as the rally continues to advance from oversold conditions – investors are “lured” back into the water as memories of the past pain fades and the “greed factor” overtakes their logic. Unfortunately, this buying always tends to occur at, or near, market peaks.
Lance Roberts provided some great advice which you aren’t likely to hear from the cheerleading perma-bulls – such as, “getting back to even is not an investment strategy.”
As a longtime fan of the Zero Hedge blog, I immediately become cynical at the first sign of irrational exuberance demonstrated by any commentator who downplays economic headwinds while encouraging the public to buy, buy, buy. Those who feel tempted to respond to that siren song would do well to follow the Weekly Market Comments by economist John Hussman of the Hussman Funds. In this week’s edition, Dr. Hussman admitted that there may still be an opportunity to make some gains, although the risks weigh heavily toward a more cautious strategy:
The bottom line is that near-term market direction is largely a throw of the dice, though with dice that are modestly biased to the downside. Indeed, the present overvalued, overbought, overbullish syndrome tends to be associated with a tendency for the market to repeatedly establish slight new highs, with shallow pullbacks giving way to further marginal new highs over a period of weeks. This instance has been no different. As we extend the outlook horizon beyond several weeks, however, the risks we observe become far more pointed. The most severe risk we measure is not the projected return over any particular window such as 4 weeks or 6 months, but is instead the likelihood of a particularly deep drawdown at some point within the coming 18-month period.
Economist Nouriel Roubini (a/k/a Dr. Doom) provided a sobering counterpoint to the recent stock market enthusiasm in a piece he wrote for the Project Syndicate website entitled, “The Uptick’s Downside”. Dr. Roubini focused on the fact that “at least four downside risks are likely to materialize this year”. These include: “fiscal austerity pushing the eurozone periphery into economic free-fall” as well as “evidence of weakening performance in China and the rest of Asia”. The third and fourth risks were explained in the following terms:
Third, while US data have been surprisingly encouraging, America’s growth momentum appears to be peaking. Fiscal tightening will escalate in 2012 and 2013, contributing to a slowdown, as will the expiration of tax benefits that boosted capital spending in 2011. Moreover, given continuing malaise in credit and housing markets, private consumption will remain subdued; indeed, two percentage points of the 2.8% expansion in the last quarter of 2011 reflected rising inventories rather than final sales. And, as for external demand, the generally strong dollar, together with the global and eurozone slowdown, will weaken US exports, while still-elevated oil prices will increase the energy import bill, further impeding growth.
Finally, geopolitical risks in the Middle East are rising, owing to the possibility of an Israeli military response to Iran’s nuclear ambitions. While the risk of armed conflict remains low, the current war of words is escalating, as is the covert war in which Israel and the US are engaged with Iran; and now Iran is lashing back with terrorist attacks against Israeli diplomats.
Any latecomers to the recent festival of bullishness should be mindful of the fact that their fellow investors could suddenly feel inspired to head for the exits in response to one of these risks. Lance Roberts said it best in the concluding paragraph of his February 21 commentary:
With corporate earnings now slowing sharply, the economy growing at a sub-par rate, the Eurozone headed towards a prolonged recession and the American consumer facing higher gas prices and reduced incomes, a continued bull market rally from here is highly suspect. Add to those economic facts the technical aspects of a very extended market with overbought internals – the reality is that this is a better place to be selling investments versus buying them. Or – go to Vegas and bet on black.