Why Will the Bull Trap Hurt So Many Investors?

You got to know when to hold em, know when to fold em,
Know when to walk away and know when to run.
You never count your money when you’re sittin at the table.

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There’ll be time enough for countin' when the dealing’s done.
-Kenny Rogers, "The Gambler"

Markets are clearly driven by fear and greed. At Atlantic Advisors, we operate without regard for market benchmarks; instead we ask ourselves: “In the absence of a benchmark, what would you buy?” This means buying only those securities we believe have the best risk/reward profile, and steering away from those that aren't attractive - even if they're part of the benchmark.

Most money managers are driven by “beating the benchmark” - no matter how imprudent it may be to do so. Like Kenny Rogers sang in “The Gambler”, you have to know when to hold 'em and know when to fold 'em. Knowing when to “fold 'em” -- or play 'em close to the vest -- while everyone around you is partying is perhaps the most difficult task we face as investors.

I am fully aware of the Fed’s goal to both save the system and force everyone out onto the risk spectrum, but I have seen this play before. I believe very strongly that investors who believe they must be invested in risky assets at the expense of prudence will live to regret their decision.

As for stocks: When I consider the risk/reward ratio, with equities at 22 times earnings (using 931 S&P 500 and $42 in earnings in 2009), I cringe when I hear people say that stocks are cheap.

What about municipal bonds? Pundits are declaring municipals cheap relative to Treasury bonds. Treasuries aren't a good barometer, since they're being manipulated lower in yield. With insurers like MBIA (MBI) and Ambac (ABK) faltering, little if any research available on the nearly 50,000 issuers out there, and new downgrades coming in like Noah’s flood, I cringe at the idea they're attractive.

As for junk bonds: With new issuance at zero (a whopping one new issue was completed in the fourth quarter of 2009), they may seem cheap relative to Treasuries. But with the window for new money issuance closed, and money scarce, who will the buyers be? Expect a record high default rate in junk bonds in 2009-2010.

As for preferred stocks, I'm cautious there as well: I wouldn’t be surprised to see Uncle Sam step in to tell banks that they can pay neither common nor preferred dividends. Such is life under socialism.

In sum, I think many investors are being forced into taking risk so as to avoid a zero return, when they would actually prefer to play it safe. Again, I remain conservatively invested, with a trading attitude towards the best-of-breed companies and sectors - those who don't need federal assistance to survive.