“How do you shoot the devil in the back. What if you miss?” --Verbal Kint, Usual Suspects

The popular opinion is rarely the profitable one. Investors around the world would be wise to keep a finger on the pulse of prevalent psychology.

Over the years, we’ve laid it on the line in Minyanville. We were extremely bearish on the financials into all-time highs, equally cautious on crude last spring and constructive on equities as we neared S&P 600 a few weeks ago.

The pushback was palpable each and every time yet the toughest fades proved to be the best trades.

In January, we offered that 2009 would witness extreme motion and movement, with S&P 600 serving as a nadir and one or two 20% rallies littering the landscape with false hope and empty promises.

Following the recent 20% rise in the markets, we’ve seen a rush to judgment that we’ve entered a new bull market. If we apply the conventional definition of a bull market, we’ve already arrived at that turning point.

There is, however, a distinct difference between a cyclical bear market rally, as I believe we’re seeing, and secular bull market that serves as an all clear to accumulate exposure. Understanding that dichotomy—and managing risk rather than chasing reward—will serve investors in good stead.

To be sure, anecdotal evidence suggests we may have some unresolved upside business. While the current rally is the fifth such move of 10% or more since we peaked in 2007, recent market internals have been stronger than during any of those prior lifts.

Further, canvassing data since 1930, there have only been seven other periods where net breadth over a ten-day period averaged over 35% of total issues. According to our friends at BTIG, six of those seven periods found the market higher the next week, month and quarter.
That begs the question of whether historical precedent applies to a juncture unlike anything ever experienced. While many are drawing analogies to The Great Depression, I would offer that FDR didn’t know what a derivative was nor was such a high percentage of the population dependent on a finance-based economy.

The imbalances in our system have steadily built over the last decade on a cumulative basis. While the government continues to invent drugs in an attempt to mask symptoms, transfer risk and buy time, the only true medicine for what ails us is the inevitable destruction of debt.

We’re witnessing an attempt to encourage more lending akin to giving a drunk another drink with hopes he doesn’t sober up. While recent initiatives have lifted the market, the gains arrived at the expense of the U.S. dollar, which is the other side of our wishbone world.

I opined last month that a slide in the greenback was a necessary precursor to—but no guarantor of—a rally in asset classes. While that dynamic could continue, it warrants caution through a geopolitical lens. Foreign holders of dollar denominated assets have taken it on the chin since 2002 and patience is running thin.

With quarter-end on tap next week and performance anxiety palpable in the fund community, we should remain conscious that the buyers are higher and the sellers are lower. The crowd, if nothing else, has proven itself to be reactive in the face of confusion and we must always see both sides.

When the dust settles on this rally, however, hindsight will reinforce the notion that in a bear market, selling blips—as opposed to buying dips—is the stylistic approach that will provide financial staying power necessary to find our way to the other side of this prolonged period of price discovery.

R.P.