I have a jam-packed day today — Yahoo Finance, Jeff Gundlach’s Doubleline presentation, and the MSNBC’s Dylan Ratigan — but I wanted to  jot a few thoughts down before heading out the door.

The recent sturm und drang about the market pullback has taken me aback. I do not recall ever hearing so much noise about a less than 5% pullback coming after an 18% rally (see chart below).

The noise is rather perplexing. Part of the blame goes to under-invested managers who missed the Q1 rally. I have been there, and know how painful it can be. Indeed, one of the reasons short term trends tend can be self fulfilling prophecies is due to exactly that: Managers with cash to put to work responding to clients questions. There are not many things more powerful than a big client asking their advisor/fund manager “Why are we carrying so much cash with the market ripping higher?

Not ironically, the opposite does not seem to be true. The penalty for being long as the market collapses seems to be less immediate, and more modest than sitting out a monster rally. The behavioral economists note this as “Career Risk.” As markets go higher, most managers eventually get dragged in, kicking and screaming.

I continue to get the sense that many pros are still under-invested. I got a taste of that this week when an ETF holding of ours — a subject of a future post — jacked up their internal fees to what we determined was an unacceptable level. We jettisoned a 10% position across all accounts and found ourselves sitting with an equity exposure of about 50-60% (plus or minus) and a decent amount of cash and bonds. Since then, the market was down 1% and then up 1%. Our balanced portfolios should really be about 70% equity exposure, according to the model portfolio I run.

I am looking at a handful of options to redeploy the capital. I do not feel any compulsion to put the money to work immediately, and if the market comes in further it will be more appealing. Given the FOMC backdrop, the near term downside (90 days) is probably limited to 15% pullback. That number has been precisely determined by me through a highly technical and sophisticated technique known as “guessing.”

Which brings me to the headline of this post: Topping or Consolidation? Using the same insightful technique as above, I place the odds that we are consolidating at 65% and that we are topping at 35%.  My working assumption is that we will produce some more clarity from numerous factors, including market internals, over the next few weeks. I reserve the right to change my mind as new data comes in, as that will impact an even more sophisticated technique of “Quantitative Guessing” — which has worked out so well for the Fed.

Back shortly . . .


Market Swings, July 2011 – Present

Source: The Chart Store


Consolidation versus Crash (April 10th, 2012)

Category: Markets, Psychology, Technical Analysis

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

27 Responses to “Topping or Consolidation?”

  1. techy says:

    my gut feeling tells me that we may be going sideways from here onwards till fiscal policy is encouraging all over the world. right now it is austerity time!!

  2. dead hobo says:

    BR observed:

    The behavioral economists note this as “Career Risk.” As markets go higher, most managers eventually get dragged in, kicking and screaming.

    This is an excellent characterization of the ‘wall of worry’ that so many people talk about but never explain. In fact, it took me years to realize this phrase wasn’t just air headed pundit talk. I have come to accept the wall of worry as a benefit to exploit. These people are the last in at the top and the first out at the bottom. Thank you, Jesus, for these fine people. I expect many will kick into high gear and buy something next week or late next month near 1440.

    My personal feel of the markets at this time are that we are in the middle of a head and shoulders pattern that is forming and beginning the head. This will end in a reverse head and shoulders later this summer. Unless the Euro ends and all debt in Europe is forced into a write off soon, there will be several good range trades available before the next leg up at the end of the year. There’s too much liquidity to allow a crash, but not enough animal spirits to prevent a pullback or decent market oscillations.

  3. bda_guy says:

    Consolidation for now but working towards more evidence of a top later on this year.

  4. ironman says:

    BR wrote:

    The recent sturm und drang about the market pullback has taken me aback. I do not recall ever hearing so much noise about a less than 5% pullback coming after an 18% rally (see chart below).

    The noise is rather perplexing.

    If it helps understand what’s going on, let’s start by observing that it’s not noise. What has happened in the markets over the past several weeks is being very strongly driven by the fundamental driver of the market, and given what we would describe as a very low volume of noise in the market at present, pretty predictable.

    That’s also why you’re hearing such sturm und drang. The fundamental driver of stock prices has turned negative (we observe that investors are currently focused on the fourth quarter of 2012 in setting their expectations.) With that being the case, and without significant changes that would alter the outlook of investors who are focused on that future quarter, you can expect stock prices to generally follow a downward trajectory. (Believe it or not, we do expect stock prices to rise a bit before they begin falling more sharply, which we expect to play out before the end of the current quarter.)

  5. Petey Wheatstraw says:

    Being that we are still structurally unsound — as little or none of the damage of the past two bubbles, nor the lax regulatory framework that let them develop in the first place, has been fixed — I find it difficult to understand how we have rebounded this far without either the broad participation of middle-calss, mom and pop investors, or an outcry from those who should know better.

    We are Charlie Brown, setting up for a field goal, while Lucy holds the ball.

    As soon as the markets reach their previous highs, and those on the sidelines sheepishly capitulate to the unseen, mysterious, and illogical hand of gains without reason, the ball will be pulled away. Again.

    The result will be another windfall for those pulling the strings and another fleecing of those to small and/or slow to play the game with the Big Boys (please feel free to call me a conspiracy theorist, a dilettante fuck, or a permabear for holding this opinion).

    If you believe you are a high-caliber player — too savvy and skilled to be taken to the cleaners — you are the mark.

    This is clearly a bubble.

  6. Mark Down says:

    Hey Petey,
    Thanks for the hidden message. We will be on the lookout to add to our positions.

  7. gloeschi says:

    Hey Barry,

    Think about the “underinvested” argument. If I had too much cash, and wanted to put it to “work”, I buy some stocks. If I buy them from you, now you have the cash. Then you are “underinvested”. Then you go out and buy some stock… etc. The cash actually never “disappears”. It just changes hands. So if the cash doesn’t change, why would you cite it as an indicator for future stock market performance?

  8. gloeschi:

    You are making the “cash on the sidelines” argument — that is not what I am suggesting.

    You will admit that some money managers can have less equity exposure and other have more due to other asset classes. One manager can be long 80% equity, the rest cash and bonds. Another manager can be long 50% equity, 20% gold, 10% commodity, 20% bonds.

    In other words, the cash goes to other asset classes. (I assumed this was widely understood)

  9. theexpertisin says:

    I’m a fan of Jeff Gundlach. He’s a guy worth investing with, as I have.

    I wish more folks would comment on the rape of retiree income by the past, present and ongoing muzzle on interest rates. By not addressing the root cause of the deficit, older Americans scraping by on cheap cuts and generic cereal are the ones getting screwed. I guess they don’t have the media interest so much as the OWS rabble throwing some human excrement at police before they change clothes to go shopping at Whole Foods.

  10. wally says:

    “I do not feel any compulsion to put the money to work immediately”

    I do. If it isn’t in a “greater fool” equity then it ought to be getting dividends. It needs to be working all the time.

  11. cognos says:

    BR –

    As far as the cash – buy AAPL. (Or Gundlach’s fund. That guy is good. Ive been pitching him since he launched. Really its the only fixed-income fund – that I know – that’s worth owning. New PIMCO, he’s the modern Bill G.)

    As far as the markets – earnings multiple is sub 14x, balance sheets are great, last 5yrs and 10yrs are lousy. Looks like a good bet. Isn’t it just that simple?

    Unless one thinks… we’re never getting an economic / equity boom again. Yeah, prob never.


    BR: We’ve owned Gundlach’s fund for a while, and recently replaced Pimco’s fund with Doublelines.

  12. [...] seems like a lot of pros are underinvested.  (Big Picture also [...]

  13. techy says:

    gloeschi :

    Cash on the sidelines is a valid argument IMO, if I sell and take money to spend its not on sideline its out of the market. But people may have considerable cash waiting to be invested.

  14. bear_in_mind says:

    I’m not a professional investor, so I’m more invested in capital preservation and long-term gains than getting every last dip, turn and top correct. I’ve been “under-invested” since 2006, have beaten the market several years, and haven’t taken an annual loss since 2000. I figure if I can keep expenses really low and stay within a few percent of the market on these wild upside swings, that’s worth the peace of mind.

  15. wally says:

    “Cash on the sidelines is a valid argument IMO, if I sell and take money to spend its not on sideline its out of the market.”

    But who did you sell it to? Their input exactly equaled your take-out.

  16. Think in terms of asset allocation and different classes of assets beyond stocks and cash

  17. cognos says:

    theexpertsin -

    How are seniors and retirees “scraping by”?

    First, they all got to retire at 60-65 (thats insane and silly).

    Second, they got (AT LEAST) basic social security benefits of $25,000 per year. Seriously! Even if you didn’t save 1 single damn cent, and you didn’t get ANY pension from your employer.

    So at $25k per year… one can live DAMN nice in many places in the central US. Or in Puerto Rico, Mexico, etc.

    If you have less money than your friends and the people around you… and you feel “poor” despite living pretty well. STOP COMPLAINING and get over yourself. Welcome to the club of 99% of people. Or better yet, get a job… start a business. The rest of the world (govt, other tax payers, Wall Street) is not here to provide you a better standard of living. You can do it. Or you can be pretty content with the unbelievable wealth level we currently have (its truly, unbelievable).

  18. Greg0658 says:

    1st the Billy Preston kinda day! post was most excellent .. roundnround roundabout

    2nd Cognos you seriously need to be slapped up side the head .. what do you want old people to do when the kids are waiting in the wings .. SERIOUSLY .. ok ding – pass on the knowledge BEFORE its to late

  19. RW says:

    The “cash on the sidelines” argument is probably valid for a very simple reason: It doesn’t confuse real-world behavior with an accounting identity.

    The fact that all transactions must balance is an accounting identity — cash and items simply change hands w/ instantaneous balance and this true by definition — and while this concept is essential to maintaining the books in a rational system the real-world behavior it describes could only exist in a strict barter economy with absolutely no credit available; any pledge, even of your first born (assuming s/he wasn’t born yet) would introduce intermediation and time value

    It’s been a long, long time since humans lived in a strict barter economic world and maybe we never did but, regardless, we certainly don’t live in that world now. Savings only equals investment as a necessary and useful accounting tool, in reality it probably never does.

    NB: Some incredibly smart people fall into this trap so it is clearly not some minor fallacy, it’s a major category mistake and those can be the very devil to analyze, particularly if your Ph.D. was in accounting; see Behavioral Relationships, Equilibrium Conditions, Accounting Identities… viz

    You use the behavioral relationships to understand how people will act in the economic environment.

    You then check the equilibrium conditions to see, given economic policy and the economic environment, which configurations of the economy are self-consistent equilibria.

    You use accounting identities as part of the paperwork to keep track of what the behavioral relationships and equilibrium conditions are.

    You don’t base explanations on them. You don’t say …”when new savings are used to buy government bonds, the people who sold the bonds must do something with the proceeds. In the end, the new savings have to work their way through to new private investment…” and think that you have made an argument.

  20. wally says:

    “Second, they got (AT LEAST) basic social security benefits of $25,000 per year. Seriously! Even if you didn’t save 1 single damn cent, and you didn’t get ANY pension from your employer.”

    Could you explain that in more detail. cognos? I’d like to find out why I’m missing out.

  21. techy says:

    “Cash on the sidelines is a valid argument IMO, if I sell and take money to spend its not on sideline its out of the market.”

    But who did you sell it to? Their input exactly equaled your take-out.
    [techy]Their input:cash is invested, my output cash is out of the market.

    Maybe new money comes in but does not get invested and that become cash on sideline. I think there is always more money coming in(due to rising income from investment, dividend etc) and that can sit on sidelines.

  22. RothcoUDipthtick says:

    In terms of ‘under investment’ – Guess that fall under market internals…

    Weekly Fed release of money market funds (highly correlated to conference board consumer confidence index)

    Average 1m rolling beta of mutual funds
    retail fund flows
    #insider sellers
    marginal debt
    mclellan oscillator
    NYA 50MA, 200MA
    stock buyback vs stock issuance

    These things a few weeks ago, were actually signalling that managers were ‘all in’ cash was low – in fact this gave you the clues alone that markets would probably pull back. Although you could have used many other indicators related to the economy and sentiment etc….

    So personally, I’m not really buying the underinvested argument from managers. What was interesting to note recently was the #insider sellers and the fact that retail guys sold out (they must still feel burnt from 2008 and are still proportionately ‘underinvested’).

    Pretty much every manager I was talking to over the last month was taking some risk off the table…

    My guess is a consolidation. But an escalation of the European crisis in the summer is quite probable, followed by more central bank action. A French Socialist president does not a happy Germany & ECB make. – throw lack of liq for Spanish bank refi in to the mix to provide support for the sovereign, around the same time – its a recipe for volatility.

  23. scm0330 says:

    Barry – why not sell covered index or single-name puts with the idle cash? Ladder things out over, say, 3-4 months. I like to think of this strategy as patiently underbidding the market, and earning 10% +/- (annualized) while you wait…


    BR: I am not a fan of low probability, high cost events. Naked put selling is that exact scenario. You assume a lot of risk for a modest amount of upside. This is especially dangerous in managed client accounts. In the low probability event of a major correction or crash, the option writer is screwed !

  24. scm0330 says:

    Couple things…I only do cash-covered, not naked. I view the technique as a split approach which earns “interest” on cash while planning potential entry points into names; bidding for things I want to own, just at lower prices, having done the fundamental work. Depending on the name and vols, strikes @ typically 10% from current levels, with the put sale occuring after some stock weakness to goose the premium.

    A good example typifying the approach was selling June 60 puts on NSC when it sold off in Feb following the “coal scare.” Pull up the chart and you’ll see what I mean.

    If things get worse for a name you’ve sold puts on, and you’ve misjudged the long opportunity and don’t want to own it at the strike (or lower), you can always take your lump and buy back the put at a loss. This will hurt your overall return. Conversely, a put that loses value quickly can be bought back earlier than expiry for a higher IRR and the money rolled to a new position.

  25. cognos says:

    Wally -

    Are you over 65 y.o.? Do you live in the United States and did you work for a dozen or so years of your life, pay taxes, etc?

    If so… back in the 1930s, FDR put in place a program called “social security”. Its pays older retirees a basic income level (about $20,000 annually) so that they won’t be destitute in old age.

    If you really are over 65 and have never heard of this… (“why Im missing out”) – you definitely should look into it.


    (Or you think I wasn’t suppose to mention social security when some old a-hole is whining (its markets, no whining!) about his interest rate not being high enough on his savings? That HE doesn’t have the sense to make better investments with. Uses the line, “raping of retiree income… scraping by on generic cereal”. God… 20 yrs of sitting and doing nothing… too many prescriptions and complaining about how… sitting around… you don’t get enough interest (as “rape”, seriously!). And 20k per year (plus ANY savings, pension, etc)… only buys generic cereal. Oh someone rescue the poor retiree from their American 20-yrs of driving the RV and going on cruises.)