Sunday, September 23, 2012

Are Sluggish Earnings The Beginning Of The End?

I, like many investors, professional and individual alike, have been skeptically bullish on this global QE/stimulus/money printing driven market for 4 years now, and all with one hand on the sell button. Although I may have missed some of the upside by focusing on investments that pay higher than normal dividends and interest, it has been the goal to participate while taking less risk.

The world economic situation is a contradiction in and of itself. After all, the answer to a debt problem cannot possibly be more debt, right? Life would be so easy if every time we had a recession the answer was simply to print more money without consequences, but it doesn't work that way.

The problem is that it can seem like all things are rosy for an extended period, like now. There is no limit to a house of cards being built, but the taller it gets it certainly could generate a false sense of security. It can kind of give you that, "This Time Is Different" feeling Reinhart and Rogoff wrote about, and of which I discuss in Facing Goliath- How to Triumph in the Dangerous Market Ahead.

One of my favorite sayings is "The market can stay irrational for longer than you can stay solvent", and it obviously works in both directions. However, as a professional, I am constantly on the lookout for warning signs that armor is crinking.

I am not shy to say that the hair on the back of my neck (if I had any) started standing on end last week when earnings, and more importantly revenue numbers, came out for both present and future predictions and were below expectations. Nearly 2 out of 3 companies has disappointed. This, I have said, will likely be one of the major warning signs. The problem is that it can go on longer than anyone thinks it can. Is this the beginning of the end?

Naturally it's better to be safe than sorry, at least on the surface. Yet, no one wants to sit on the sidelines while the market goes up no matter what they say. Realize however, that there is no bell that rings when it's time to get out. We must keep in mind that this bull market is much older than the average and that we are certain to see some sort of spending cuts and tax increases next year which will slow down an already anemic economy,so it is time to revisit your personal exit strategy.

Timing is everything. So when do you pull the trigger? Well, at the moment the market does have a couple of things going for it. We see a sea of liquidity with no place else to go. More importantly, too many people are waiting for it to happen. If a crash occurred soon, a huge majority of investors would be right, and the market never makes the majority right!

So, even though this current correction has been ugly and other warning signs are there, I would not be surprised to see new highs after the election. After that, it may finally be time to take some risk off the table and be happy with above money market rates and inflation. I know the market historically says it generates about a 10% return, over the very long term, but for that there is simply way too much risk.

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