Bulls vs. Bears: Q4 2011 Edition

You don’t get harmony when everybody sings the same note.

~Doug Floyd

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 recentlyย  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.

The Bull

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:

  1. 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.
  2. 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.
  3. 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.

The Bear

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)

Written by Kim Petch

7 Responses to Bulls vs. Bears: Q4 2011 Edition

  1. I have put options for hedging, but I expect to see a decline in my portfolio today with the Italian situation. I fear that the contagion will start to spread and that the world will be tipped into recession in 2012. I suppose that is how I will prepare.

    • Recession does seem more likely each day. If the credit situation doesn’t stabilize, it’s a certainty. Markets look like they’re headed sharply lower this morning and I expect that will continue until the next “rescue” headline crosses, sending shorts scrambling to cover. More volatility seems like the only discernible trend. ๐Ÿ˜•

      Thanks for sharing your ideas!

  2. It has been a while since I commented here but I do read all your posts -great blog BTW. I am very much bearish for the world economy, especially the Euro zone debt issue and potential China hard landing on housing/building bubble. This will impact the Canadian equity markets and the loonie, as the flight to the safety of the dollar is likely to happen again. It would possibly thus make sense for Canadians to look south for solid US global companies that may trade at bargain price once/if the US equity markets tumble, along with all global equity markets.

    Now, one must be in US assets (US dollars) to be able to play the USD currency advantage in the flight to safety. Lots of people say that US Trasuries are in a bubble. I have trouble believing this. Long term Treasuries will become problematic ONLY when interest rates go up, and that is unlikely until 2013. So, probably better to stay in short term issues. Even if US Treasuries are at a high price and low yield, it might make sense to buy those soon, for Canadian seeking diversification and some kind of insurance policy or potential opportunity, as the loonie is not so bad now, possibly through buying short term US treasury ETF like SHY (iShares Barclays 1-3 Year Treasury Bond). Right now, inflation is not an big issue (mostly commodity cost-push inflation), but it may at some time in the future, then strong global companies listed in the US would possibly be able to keep up with it.

    What do you think?

    • I see your reasoning in wanting to take a position in U.S.-based assets as our neighbours to the south are steadily gaining a reputation for being “the best house in a really bad neighbourhood.” Personally, I like to keep most of our investments in Canadian dollars. This is mostly because I like to keep things simple, and partly because I’m not sure how long the U.S. can maintain it’s preferred global standing. If I wanted exposure to U.S. dollars, I might consider an ETF … but I’m not that adventurous at the moment. ๐Ÿ˜‰ Still, I think you have the right idea waiting for prime assets to become undervalued.

      In terms of Treasuries, I think you’re right. It will likely be a year or two (or more?) before rates rise given the global growth slowdown. Having said that, I still don’t want to own them. For me the yield isn’t worth it and and I don’t want any capital at risk when the turn does happen. I prefer good old GICs to bonds right now.

      It’s interesting you mentioned China. I haven’t written about that for some time now, but I’ve been watching as more warning signs seem to be coming with regard to a hard landing for the real estate market there. (I know many are watching the Shanghai Composite as a leading market indicator.) While I think China will continue to be an engine for global growth in the future, I’m cautious about the potential for some kind of crisis there over the medium term. I’m just hoping it doesn’t happen at the same time this European problem comes to a head.

      While I’m very cautious in my outlook for the next 5 years or so, I do think we’ll get through all of this if for no other reason than we have to. In the meantime, I’m happy to remain mostly in cash and trade a small portion of the portfolio very cautiously – tight stops with an emphasis on capital preservation rather than capital gains.

      I’m not sure whether I adequately answered your question or not, but thanks for asking and thanks so much for reading. ๐Ÿ™‚

      • I think your strategy is sound. I am currently 80% in GICs and 20% cash (in CDIC insured Investment savings account “MIP 710”.

        It is that 20% that I am assessing whether keeping in cash or to deploy in anticipating the loonie going down during a pending market downtown… Will the bargains be better in Canada or the US? Oh, greed, greed… ๐Ÿ˜‰

        • Oh I see. I didn’t realize you were only talking about a small portion of your investable funds. Position size is everything isn’t it?

          As for the Canada/US question, I just don’t know. I suspect there will be some good bargains on both sides of the border. If Europe decides to print money, however, I think Canada will have the edge thanks to our heavy commodity weighting.

          Thanks again for sharing your thoughts Bruno!

          • I agree. Apart from the fact that there does not seem to be any good investment out there, as yields are so low and equities are overvalued, the main investment challenge that I find now is that our investment choices are more impacted by government policies and the associated uncertainty, rather than from economic analysis and asset valuations. So it is all a guessing game on what politicians and economic institution leaders will do.

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