You don’t get harmony when everybody sings the same note.
Every so often I like to write about what the bulls are saying versus what the bears are saying. Usually, both make a pretty good case. That doesn’t make it any easier for investors to make decisions, but it does offer them some balanced information which they can then use in any way they like. Today’s bull vs. bear debate zeroes in on a few specific factors rather than presenting a comprehensive overview.
I recently came across two differing takes on the market heading into the end of the year. The fourth quarter is often pivotal for portfolio managers as it’s their last chance to meet or beat their benchmark. Like it or not, that’s the nature of the game and it can affect markets as investors jump on trends in an attempt to cross the December 31st finish line ahead of the competition.
Barry Ritholtz is hardly a permabull, but he began to put more cash to work around the third week in October. He explains several reasons for his Tactical Shift in Portfolios:
- Seasonality: November and December are typically the months of the year when the stock market performs best. They kick off the seasonally best 6 months of the year, which usually run from November to April.
- Sentiment: Excessive bearish sentiment exhibited in extremely high short interest had many hedge fund managers poorly positioned for a snap-back rally. Short-covering can ignite and propel a rally even in the absence of strong fundamental underpinnings.
- Market History: The type of “buying panic” by investors at the beginning of October has few historical precedents. In just 5 trading days the S&P 500 shot up 11.4%. On the relatively few occasions this has happened in the past, markets experienced healthy gains in the following weeks more often than not.
But . . . Ritholtz is careful to point out that he is still a subscriber to the secular bear market thesis. He thinks “a recession is more likely than most economists expect” and that markets will eventually head lower. For the next few quarters, however, factors like seasonality and sentiment may trump economic fundamentals.
I recently came across an interesting article that offered a compelling technical analogy between the current market environment and the one that preceded the 2008 crash. According to Short Takes, Stocks Dropped 54% After a Similar Point in 2008. If you’re into charts, this post has a few that may help to remind us that seasonality, sentiment, and history work some of the time, but that they all go by the wayside when markets truly break.
On the other hand, the fact that the charts are setting up in a similar way to those of 2008 does not make another crash a foregone conclusion. It’s just another data point to put in your arsenal for consideration. The reality is that markets can and will move in either direction over any given period of time and the only way to navigate that kind of capriciousness is to have a rigorous risk management discipline in place.
And the Winner Is . . .
Just kidding, of course. You know there’s no winner. 2011 has been a poster child for the type of volatility we would expect to see in a secular bear market. Both bulls and bears can get repeatedly whipsawed and many investors are left with a serious case of motion sickness. Neither bulls nor bears can claim a clear victory.
In this type of market, those with a solid plan and a thorough understanding of their personal risk tolerance will thrive. They will not cling to either bullish or bearish expectations, but having a pretty good understanding of the kind of ride they’re stepping onto, take appropriate precautionary measures.
Those measures may include reducing equity exposure, setting prudent stop loss levels, or buying when valuations become attractive. Investors may choose to implement any or all of the above to manage risk. In this kind of secular bear market, it’s more important to understand the investment context and perhaps more importantly, yourself than it is to track every news headline that crosses the wire.
How are you handling the volatility of 2011? Are you more optimistic heading into year end?
(Photo Credit: Shutterstock)