Five Reasons For Optimism
The world is tough and the market is frustrating. That much we know and with each step we learn...
--Cousin Eddie, Vegas Vacation
It's rough out there, as anyone within shouting distance will tell you. And make no mistake, there's a lot of yelling going on. Main Street is screaming at Wall Street, politicians are barking at each other and there's a heightened state of tension spreading throughout the world.
While it's easy to get caught up in the doom and gloom, we must remember that the sword swings both ways. An ability to view obstacles as opportunities is the hallmark of human spirit and silver linings exist in this economic twist. The credit crunch is more pervasive than the dot.com and real estate crazes but we've been there and done that on both sides of the bubbles.
As the only difference between mistakes and lessons are an ability to learn from them, we would be wise to recall the past as we cast an eye towards the future. It will be a long hard road but as with any journey, it will be ripe with uphill climbs. And as always, the path that we take to get there is entirely more important than the destination we arrive at.
We've been cautious on the big picture for quite some time. While it's not a good idea to be a contrarian for the sake of swimming against the tide, there is certain utility in variant opinion. With a conscious nod that hope isn't a viable investment vehicle, we wanted to highlight a few reasons for optimism as negativity swirls through the street.
Taking Our Medicine
2008 is off to the worst start in the history of the financial markets and it's difficult to put lipstick on that pig. There are ample opportunities to prosper however, particularly for those who have proactively prepared. If you didn't see this coming, fear not. It's never too late to begin the process of financial awareness.
Market corrections are a function of time and price. We've long offered that cumulative imbalances were percolating under the seemingly calm surface and now they're out there. The first step towards solving a problem is admitting that you have one. That process is now in motion.
The upside of anger is that the market has already begun to price in a recession. Citigroup (C), Merrill (MER), Intel (INTC) and other market leaders are off upwards of 50% from last summer's levels. Even if the worst-case scenario plays out and depression looms, perception will take time to catch up with that most unfortunate reality.
Capital preservation, debt reduction and financial intelligence remain key elements in the long-term perseverance process. There are no blanket answers as each individual has a unique time horizon and risk appetite. There are, however, many ways to win if we're disciplined, informed and in tune.
Real Estate Bargains
With the implosion of the housing bubble, property values have come crashing back to earth. That's a bitter pill for holders of real estate but it presents an opportunity for folks who have patiently waited on the sidelines.
Just as it felt like we would never recover from that post-bubble technology spill, a similar mindset has emerged in this asset class. There is more carnage to come and this isn't a call for a bottom, per se. It's simply an acknowledgment that bargains exist for those with the proper means.
Nobody likes to prosper from someone else's pain but the sad truth is that the other side of the real estate bubble is upon us. There are 1,500,000 properties currently in the foreclosure process and that means that someone is going to pick up a home on the cheap.
It might as well be you!
At some point during the past ten years, the collective consciousness began viewing profits as a right rather than a privilege. That manifested in many ways, including the home equity binge and credit dependence. Consume now, pay later and finance at zero percent. It seemed too good to be true and with hindsight, it was.
So, what have we learned? There is an eye-popping abundance of debt in the system, the world is woven together with $500 trillion of derivatives and if risk has indeed segued from stagflation to deflation, commodities are vulnerable and the dollar should rally.
While it's been a painful path from the October highs to the current sighs, we've gleaned valuable insight. We've been watching the "lower highs and lower lows" for months and they've painted a powerful picture. Until that pattern is broken-and we've got room to run on the upside before it is-selling rallies (rather than buying dips) should serve us in good stead.
Babies in the Bathwater
One of the more disturbing elements of yesterday's lift off the lows was that the best performers were "pay me now" plays. As important as the financials are to the DNA of the marketplace, the sharpest rallies occur in the context of a bear market. The same can be said for the small caps, homebuilders and retailers, all of which ripped higher out of the gate.
In a slowing economy, pharmaceuticals and consumer non-durables typically exhibit relative strength. That didn't happen yesterday. In fact, they were two of the worst performing sectors on my screen. While I rented financials and beta as vehicles for a pure trade (most of which has been sold), I started sniffing at some names with a longer-term lens.
Altria (MO), Johnson & Johnson (JNJ), Merck (MRK), Anheuser-Busch (BUD) and Coca Cola (KO) all fall into that traditionally defensive complex. If my ten themes of 2008 play through, they should perform quite well versus their more aggressive brethren.
Engine Room, More Angst
Trading moves traditionally migrate through three phases: denial, migration and panic. While the mainstream psyche continues to adjust to the notion of recession, the stock market, as a leading indicator, has already begun discounting those prospects.
In a perfect world, we would prefer volatility measures to spike to previous pain fulcrums. While that didn't happen-the VXO top-ticked at 39 yesterday, well below previous readings of 57-there are indications that the crowd may be getting a tad too negative.
The American Association of Individual Investors is at the second lowest level since its inception in 1986. Odd-lot option traders have turned excessively bearish. The 10-day average of the CBOE equity put/call ratio recently ticked at the second highest reading in history, behind only the days immediately following the terror attacks of 2001.
While the potential for redemptions and forced selling remains, the path of maximum frustration may be pointed higher for the first time in a few months.
It Could Be Worse!
The world is tough and the market is frustrating. That much we know and with each step we learn. With time comes experience, however, and quite hopefully, balance.
It should never take something bad to make us realize we've got it good. As the greatest wisdom is bred as a function of pain, perspective is important.
Minyanville's elder statesman Charlie Mangano said to me yesterday, "I've been around the block. In the early 70's, Wall Street was over. In the late 80's, the market was dead. In the 90's, we caught the Asian flu. We've been through worse and we'll get through this."
Smart words by a sage man and I wanted to pass them along. No, it's not going to be easy but nobody said it would be. We've got a long journey ahead, fraught with risk and littered with reality, but it's the path we've chosen. We indeed live in interesting times.
Would you have it any other way?
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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