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In Credit Unwind, Earnings Estimates Are Shots in the Dark


Long-only equity investing highly risky over the next few years.

Whoa, we're halfway there
Livin' on a prayer
Take my hand and we'll make it - I swear
Livin' on a prayer
Jon Bon Jovi, Livin' on a Prayer

It's often said that "hope is a poor roadmap to success" - an adage perhaps truer in investing than anywhere else. I admit, I've sometimes found myself hoping that an investment or trade that had gone badly would come back. I must also admit that I can't recall a time when I was rewarded with success just because I hoped for it. It's also why I've learned to take losses when they're still manageable, in observance of the old maxim: "Good traders know how to take gains, but great traders know how to take losses."

I'm not saying I'm a great trader - but admitting defeat is key to investing. Simply put, if I find myself wrong-sided, I "cut my losses and run" - quickly. Better to lose 10% and need to earn 11% to get to break-even, rather than losing 50% and needing to double your money just to break even.

And if you think hoping is a poor roadmap to success, praying that your asset will magically come back in price is even more dangerous. Mind you, this isn't commentary on religion; it's just the single most prevalent mistake being made these days: "Living on a wing and a prayer."

What's Wrong with the Global Markets?

As equity and debt markets sink around the world, I'm constantly asked why prices are falling. I could spend pages and pages explaining why prices have sunk and will continue to sink (though not in a straight line, of course) over the next couple of years. Simply put, markets are sliding down the "slope of hope."

Bull markets are said to climb up the "wall of worry"; in direct contrast, bear markets slide down the "slope of hope." When investors give up hope and capitulate to the point of despondency, enough fear has been injected into the system that the market can then climb the "wall of worry."

The "slope of hope" has some easily identifiable characteristics: Low cash levels in the mutual fund complex, low levels of short-selling activity, and, most importantly, a serious case of denial, otherwise known as "I don't want to open my brokerage statement" syndrome.

Another symptom of the slope of hope is this: Consultants and advisors -- the ones who've been wrong-sided the whole way down -- will tell you to "stay the course as markets rise over the long-term, dollar cost averages," etc. This sort of activity continues until the road to capitulation begins and fear takes over. With fear comes high cash levels, loads of short-selling and a general disdain for stocks in general.

When I walk into a bar and see ESPN on the TV rather than Bloomberg, I know we're getting closer to a bottom. When I see a bear on the cover of major financial publications, I'll know that we're getting closer to a time to take risk again.

The main point I wish to make is that, when earnings expectations have fallen enough that they're likely too low, then it will be hard to disappoint investors. At present the biggest problem in the markets is that earnings estimates are woefully too high. This is otherwise known as a "value trap."

As I sit in front of my Bloomberg terminal during the peak of earnings season for the S&P 500, I see a stream of earnings misses and lowered guidance. I've been around the industry for quite a while, but the amount of misses/lower guidance seems more prominent now than at any other time that I can recall.

So, from a "bottom-up" or individual-company standpoint, analysts' and investors" expectations are still way too high - and they can only be disappointed.

Click Here to Purchase "Bond Basics: A Q&A with Bennet Sedacca"
No positions in stocks mentioned.

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