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How to Survive a Sideways Market

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There may be a massive shift from fixed income into dividend-paying stocks, such as Johnson & Johnson.

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From Ira Berkow; Sports section of The New York Times, 1/19/94:

"Sure Babe Ruth was good, but could he play hoops?"

...The answer is, the Babe played hoops at least once according to his biographer, Bob Creamer, in a pickup game with high school varsity players and looked "pretty good." It is fairly certain, however, that the Bambino was not Air Ruth.

...The fact is that even for the greatest physical specimens, going from one sport to another and competing at high levels – let alone the highest levels – may not quite translate, for a variety of reasons.

The man who was called "the greatest athlete of all time," Jim Thorpe, was an Olympic decathlon champion and star football player who, a teammate said, "could outrun a deer." But he was a bust as a major league baseball player.

...It seems that the hardest thing to do in sports is something that you may not have been trained in at an early age to develop the muscle memory, may not have the desire or may not have developed the requisite physical and mental skills.

Some talented athletes have been driven out of baseball because they feared being hit by a pitch. "Stepping into the bucket" is the next step to departing the game. Fear of injury plays a role in sports, and while one athlete may deal with it in one arena, he may not in another.

A Wall Street parallel: It seems that the hardest thing to do in investing is something you may not have been trained in at an early age (especially the 30-something mutual fund managers): How to survive a sideways market. The memory and experience are not there because the majority of Wall Street's brokers and fund managers have never lived through a 12-year wide swinging trading range stock market like the 1966 – 1982 affair, let alone live through a real bear market like 1973 – 1974. Most were in grade school back then. Such thoughts conjure up memories of the ubiquitous advertisement during the 1973 – 74 bear market showing a kid riding a tricycle with the verbiage, "What was your mutual fund manager doing during the last bear market?" Indeed, the past 12 years has been pretty tough with the S&P 500 (SPX) trading in a range between roughly 700 and 1500 punctuated by multiple tactical bull and bear moves. Consequently, not many portfolio managers have been able to outperform the overall stock market averages. Indeed, year-to-date (YTD) of the 515 mutual funds that benchmark themselves against the SPX, or similar index, only 24% are beating said index. For the other 76% the fear of stepping into the "bear bucket" is the next step to departing the Wall Street game entirely. Fear of losses and poor performance play a role in investing and while a young perpetual "bull" may deal with it in an easy-to-win up-market, they may not in a sideways to down market.

Such frustrations are being reflected in ISI's latest hedge fund survey that shows long equity exposure has declined to 44.1%, which is lower than the 47.2% equity allocation at the August 8/9 "emotional low" of last year. Meanwhile, retail investors are on track to redeem another $5 billion from equity-centric mutual funds this month, bringing the YTD total redemption to about $37 billion, the second biggest outflow next to 2008. Then there is the shrinking stock exchange volume combined with investor apathy as reflected in the AAII's (American Association of Individual Investors) survey that week before last had the "bulls" at only a 22.19% reading. Typically when the bullish sentiment reading is below 25%, stocks rally on average 5% -- and that is exactly what happened last week as the SPX climbed 4.3% from Tuesday's intraday low of 1329.24. Plainly, the two major market moving news items were rumors that the Federal Reserve is going make a policy announcement at this week's FOMC meeting, and then there was this quote from the European Central Bank President Mario Draghi:

Within our mandate, the ECB is willing to do whatever it takes to preserve the euro and, believe me, it will be enough.

As stated in Friday's verbal strategy comment, such an ECB statement should come as no surprise, for I have opined for months that: 1) you don't throw $1 trillion at a problem and then walk away if it doesn't work, the world just doesn't work that way; 2) politicians, bureaucrats, and bankers are the same in Europe as they are here; they do not want to lose their power -- and if the EU implodes, they all lose their power; and, 3) if the EU implodes, there will be no need for the ECB! Hence, I take Mario Draghi at his word that, "Within our mandate, the ECB is willing to do whatever it takes to preserve the euro and, believe me, it will be enough."

Speaking to this week's Federal Reserve meeting, I continue to think the odds of a policy move are high because if the Fed waits until the September meeting it will be viewed as being too political with the presidential election so close. To be sure, just like the Supreme Court did not want to "step into the [too] political bucket," I don't think the Fed wants to do that, either. The risk then becomes: If the Fed stands pat at this week's meeting, how does the stock market react? My hunch would be that the SPX stalls out at current levels, but doesn't necessarily have a big decline. The quid pro quo is that if in the near term euroquake has really been taken off of the table, and if the Fed does adopt a QE3 type of policy at this week's FOMC meeting, last week's upside breakout by the SPX above the 1360 – 1366 level could prove sustainable, leading to another upside breakout above the May reaction high of 1422 amid universal disbelief. Worth noting is that, according to the astute Bespoke organization during the fourth year of the presidential cycle, August has been up 67% of the time with an average gain of 2.3% (helped by a 14.1% gain in 2000). The best August ever for the OTC was 2000's +14.1%, with the worst performance in 1998 of -19.0%.

The call for this week: A number of "trees" fell in the forest last week and nobody was around to hear them. First, after extensive studies requested by local residents, the EPA has determined the drinking water in Dimock, Pennsylvania has not been contaminated by the use of fracking. Maybe that's why the energy sector was up by 1.94% last week. It was bettered, however, by the financials (+2.82%) and materials (2.51%), which is pretty strange sector rotation if we are heading into a recession. Second, Reuters reported that three of the nation's largest public pension funds have announced investment returns of between 1% and 1.8%, which is far below the 8% that large funds have typically targeted. As repeatedly scribed in these missives, when it becomes apparent that our economy is not headed into recession, I think there will be a massive shift from fixed income into dividend-paying stocks, such as Johnson & Johnson (JNJ), which is rated Outperform by our fundamental analyst. As often stated, I would much rather own a good dividend-paying stock for the next 10 years rather than the 10-year Treasury Note.
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No positions in stocks mentioned.
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