Sell equities
In late August, I wrote a post called “Getting bearish again” in which I said that the bear market rally I had anticipated back in March was long in the tooth. At the time, I mentioned 1026 on the S&P 500 as a sell signal. With the S&P 500 now well over 1060 and gains of well over 50% from those March lows, it’s definitely time to sell.
And when I say sell, I’m not talking about going overweight bonds or commodities by putting additional new money disproportionately in other asset classes – which is what you should have been doing in August. I am talking about lightening up on equities and selling existing positions.
Now, if you missed the rally, I’m sorry but, now is not the time to get in. And if you have been there from the start, remember, bulls make money, bears make money but pigs get slaughtered.
David Rosenberg sums up the logic.
The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation — usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs — during this extremely flashy move, the U.S. has shed 2.5 million jobs (as may as were lost in the entire 2001 recession).
Do you really think there’s huge upside here? After a 60% run to the upside? Laszlo Birinyi does and sees 1200 before year end. I’d rather sit this one out. The downside is a lot greater at these levels than the upside. I would say lighten up on risk all around. High quality over low quality. Low beta over high. Consumer staples over discretionary.
But, if you are not going to run with the liquidity-seeking-return crowd and chase high beta and low quality stocks or high yield bonds, where do you put funds? After all, Bernanke and company have made sure cash is trash by lowering rates to zero.
Here are three ideas.
Government Bonds
Has anyone noticed the yield on treasuries? It’s falling. For example, a month before Labor Day on 7 Aug the 30-year yielded 4.61, the 10-year was yielding 3.89 and the 5-year got you 2.84 (see 2009 data here). Today, we are looking at 4.18, 3.40 and 2.38 (data here).
Meanwhile the dollar is getting crushed – approaching parity with the Swiss Franc. Everyone is shouting “recovery, recovery,” as if that’s the reason that the U.S. Dollar is falling. So then, why are government bond yields exploding to the downside even while the U.S. government budget deficit spirals upward? It doesn’t sound like the bond market is expecting a very robust recovery. Pimco, the world’s largest bond fund, is already in this trade. They have been loading up on treasuries of late – bringing them to their highest relative weight in 5 years.
Gold (or platinum)
As I see it, the U.S. is likely to use the U.S dollar as an escape hatch for a very intractable debt problem. That is dollar bearish, but not necessarily bearish for U.S.-based treasury investors. A scenario in which the Dollar tanks and there is a flight to safety in Treasuries is also one in which Gold could outperform at the same time. And Gold has also been surging as well, last trading well over $1000 at $1015. If you like precious metals as a hedge against a dollar run, then platinum is a good bet as well as it has outperformed gold.
Out of the money puts
If you think this cyclical bull market (aka bear market rally) has legs like Laszlo Birinyi does, why not do a Taleb Black Swan trade via out of the money puts on Spiders (SPX) or QQQQs or some other broad market ETF? This would be a hedge – and that’s all. The benefit of such a trade is that you don’t have to sell outright. And it is de minimis in cost right now. The VIX, a broader market volatility index, is at a one-year low. So, this insurance bet will cost you less. But, the decrease in the VIX should also be treated as a contrarian indicator.
Sources
Breakfast with Dave, 17 Sep 2009 – David Rosenberg, Gluskin Sheff
Update: I just noticed that Barry Ritholtz has a post out discussing why he thinks markets can and will go higher. See his comments here. He makes valid points – based more on technicals than fundamentals. On a fundamental basis, the market is overvalued. To the degree you hold Barry’s view that the rally will continue because of liquidity, then you would want to employ the Black Swan strategy I mentioned as a hedge against downside risk.
“As I see it, the U.S. is likely to use the U.S dollar as an escape hatch for a very intractable debt problem. That is dollar bearish, but not necessarily bearish for U.S.-based treasury investors.”
Ed – well (and not for the first time) I don’t get it. By “escape hatch” I assume you mean to help reflate the economy and devalue the debt. I remember reading somewhere ages ago that for the dollar, every 10% decline (presumably against some sort of currency basket ) would result in only a 1% increase in inflation. That would mean a lot of decline for any sort of “bang”, especially when the currencies of most other developed economies want/need the same thing! If you believe (as I do) that the powers-that-be will do whatever it takes and use whatever as-yet unheard-of tools to avoid meaningful deflation (because the consequences of such deflation would make “very intractible” debt even more overwhelming), then who in their right minds would be buying U.S. Treasuries at these levels? And all this is before the Fed even starts to unwind – or (giggles) trying to unwind….
I do mean the dollar as a reflation mechanism via devaluation. A tanking dollar does not mean treasuries get crushed. Right now the dollar is falling, treasuries are rising as is gold.
You’d want to be in treasuries even if the dollar fell if you expect the deflationary forces to outweigh inflationary forces from the currency depreciation. You’d want to be in gold if you think the inflationary forces of the depreciation would feed through.
Right now, both trades are being put on i.e. gold is rising and so are treasuries. When it becomes more clear which force is winning the deflation-inflation tension, I would expect a reversal in one or the other.
Remember my post about the Scylla and Charybdis of inflation and deflation. I think that’s what we’re seeing right now.
Ed – thanks for your response. Yes, remember your S-and-C post and it was a good one, and I take your points that deflation could outweigh the (potentially limited) inflationary power of a declining $, and that we need to revisit the situation in a few months.
Until shown reasons to think otherwise, am still convinced that even a hint of ongoing deflation (let’s omit the adjective “meaningful”) a la Japanese experience will result in panic stations because it’s just too late for the hard way out because it’s now too damned hard to even contemplate!
One more thing. I am talking short-to-medium term here (until the trend is apparent and you can re-evaluate). So, come November when we have a better read on employment and what that means regarding the economy, things will look different.
Last one, I promise. Right now, it is deflation which is still the problem. Just because gold is rising, doesn’t mean it is because of inflation. It is just as likely rising due to fiat currency revulsion. In the Depression, gold rose while deflation was all around.
So, on the whole, gold is really more of a dollar crash hedge than an inflation hedge. While treasuries are not only a deflationary (disinflationary) bet but also a bet for economic weakness.
“Last one, I promise” Ed – NO WORRIES!! Feel free to keep it coming!
“(Gold) is just as likely rising due to fiat currency revulsion”
On one hand, people are revolted by fiat currencies (& buying gold because of the expected effect of current and future actions), and on the other hand people are investing in those self-same currencies longer term by buying bonds! Both gold and the bond market are coming from opposite ends of the same one-way street, so an almighty pile-up is unavoidable. However unrealistic, the American psyche will absolutely not tolerate economic weakness for any length of time, so the outcome will be inevitable (and anyway, gold is of course heavier than paper..!)
well as a footnote, the answer to who’s buying treasuries is of course obvious….
https://www.zerohedge.com/article/visualizing-upcoming-treasury-funding-crisis
Edward,
You acknowledge that the Carry Trade is a significant current contributor to dollar weakness. We have also seen that the dollar seems to perversely climb during episodes which ought to cause it further weakness, like the Meltdown, while it has dropped during perceived periods of greater stability (as we are seeing today).
I am paying close attention to reports that we are about to see two major crests of additional mortgage defaults in 2010 and 2011.
Will the dollar (in your view) rebound during the next major crisis, or will this whole “flight to quality” thing turn out to be a mirage?
Barry
I think the flight to quality talk is rubbish. The dollar is not quality. It is liquidity. And that’s why the carry trade is on, it’s all about unreasonably low interest rates encouraging risk.
Edward,
I think any reasonable observer would agree that it’s rubbish.
Having said that, is it not true that the USD has risen during recent meltdowns, even if they are of our own making? Do you think we can expect that again, or will the USD take another big hit when we have our next meltdown (e.g. when the mortgage resets arrive)?
Barry
I’m going to punt on that one. I have been mentally preparing a longer post on market volatility for ages now. I may write it soon. But, one of the conclusions I draw is that a 2 or 3 sigma move leads to a volatility and ‘chaos’ which makes forecasting difficult.
So, when meltdowns happen, there a lot unknown unknowns, if you will. And that means the only thing you can do to protect yourself is to reduce risk while still profiting from the volatility via hedges.
That is what’s commonly known as a “utility and options” strategy.
Agree w all the above, though over the years, platinum often trades at 2X gold but now is more like 33% above. Platinum is far rarer than gold. Unlike silver Pt is not a leftover metal from mining for other things. Pt cannot be bought on a US exchange in ETF form but can readily be done so on the AIM (“PHPT”).
I would also be comfortable committing new money to the boring stable stocks that have traded like Treasury bonds but have likely dividend growth. There are not many of these IMO:
I have been increasing my holdings of the stable growth stocks MCD and FPL ever since Credit Writedowns also spotted those young plants that now are nameless this spring; since even a Fake Recovery is a “recovery”, I have increased my exposure to these names. MCD has a 7% earnings yield and a 3.5% dividend yield that likely will double in 10 years or less; FPL has an 8% earnings yield and a 3.4% dividend yield, has the country’s dominant pos’n in wind power, and sells for modestly less than the sum of its conventional and unconventional power parts.
These guys have gone nowhere since the March mkt bottom and IMO are better suited for a muddle-through economy than bonds. MCD shrinks its shares outstanding; wish the Govt were doing the equivalent!
Wall Street lore also says to sell Rosh Hashanah and buy Yom Kippur!
Edward,
In this kind of crazy situation, do you have any opinion about investing in emerging markets debt (sovereign bonds etc)?