kirkydu (95.46)

Conventional Wisdom and an Unhealthy Outcome

January 05, 2011 – Comments (5)

Conventional wisdom in the financial industry seems to be that we are in a bull market, induced by government, and that the rally will sustain for another quarter or two or three then we will get a run of the mill correction.  So, what will really happen?  That's a big question, loaded like an elephant gun heading out on safari (yeah I know not PC, but a great analogy).

I know for a fact that most retail financial advisors, who are as a rule (and maybe religion) of being overly bullish, are at 70-90% invested in equities, with well over half in U.S. large caps.  Most people's 401k are also similarly domestically weighted and heavy in equities.  Seeing as both groups are great indicators of what not to do, I wouldn't do what they are doing.  I see another sell off, but under one of two scenarios, both more severe that the "conventional wisdom" of a continued rally followed by a run of the mill correction.  

In either scenario we end up with a very bad correction, possibly the type of doomsday that could drive investors away for years not because they are waiting to invest, but because they have nothing left to invest.  Remember, the baby boomers are starting to retire and are beginning to accumulate cash instead of buying financial assets.  Another kick in the jimmy could end their equity investing almost altogether.

Scenario one is that the market loses about 30% very soon.  In the next month or so, soon.  I don't think retail and non-accredited investors have much stomach left for this type of event, but this is probably the more healthy of the two scenarios as people are making some 401k and IRA contributions through April and might accidentally buy low and show enough progress in making their money back to not run away and hide again.

Scenario two is that the rally goes another 2000 or 3000 points on the DOW (the number everybody inexplicably pays attention to), then crashes by 50% or more.  If that happens, Katie bar the door, the boomers are done with the markets.  Finito, finished.  Without the boomers pumping money into equities, there is no way the equity markets do anything substantial for years.  

So, three scenarios, bad, very bad and hugely bad.  My guess is hugely bad because that's where the hucksters, hoarders, manipulators and crony capitalists make the most money.  I sure hope I'm wrong and the conventional wisdom is right.  I actually hope that the market is just beginning a secular bull market, but my bull/bear market indicator puppet doesn't think so.

What am I doing about this given that the market is trending up and I have client emotions to consider.  I am not highly diversified.  Our portfolios hold exposure to about 100 (to 200 for people who are strictly in funds) companies, about 50% internationally allocated (though most of my domestic exposure is to exporters and commodity producers), via a few focused funds and some of my high ceiling or high margin of safety ideas and hold substantial cash (20-30%).  I am also selling puts against companies, countries and sectors (commodity linked ETFs in particular where I can) I'd be willing to add exposure too.