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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. 



5 Comments – Post Your Own

#1) On January 05, 2011 at 4:32 PM, SkepticalOx (98.52) wrote:

Retail investors withdrew around $80 billion from equity funds in 2010, so I wouldn't say home investors are exactly bullish. 

Why on earth are you selling puts if you expect a correction?  

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#2) On January 05, 2011 at 4:33 PM, SkepticalOx (98.52) wrote:

Sorry, correction:

Why on earth are you selling puts if you expect a correction (that you say to not know how far it'll fall)?

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#3) On January 05, 2011 at 4:54 PM, Option1307 (30.58) wrote:

Intersting thoughts, thanks for sharing.

...and that the rally will sustain for another quarter or two or three then we will get a run of the mill correction.

Couldn't this be become somewhat of a self-fulfilling prophecy, i.e. everyone will be buying the "run of the mill dip" and prevent a larger correction?

I don't like when everyone is on the same side of a trade or predicting the same thing, which we have right now. This definitely makes me cautious. However, with that being said, sometimes it's best not to fight the crowd.

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#4) On January 05, 2011 at 5:57 PM, leohaas (30.13) wrote:

I can come up with at least a dozen other scenarios. Some of them worse than the ones you describe, and some of them a lot better. But that does not mean any of that is going to happen.

Keep on dreaming up scenarios. I don't think the market will stick to any forecast. If it did, the forecasters would be rich. And considering that they are not sipping a pina colada somewhere on a very nice beach, but rather, still making new forecast, they are not...

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#5) On January 06, 2011 at 12:44 AM, kirkydu (90.68) wrote:


I sell puts so I can participate in this melt up to some degree.  The durations are from January to July and in general 10-30% out of the money.  Also, what I'm selecting is less risky in general to begin with.  I'm taking about 50% of the market risk if I'm rightish about things and have about 75% of the upside.   If the market rises another 20% and I make 15%, I'm fine with that, especially with the cash secured puts expiring and leaving me with cach to reinvest or hold on a regular monthly basis.  If it drops 30% and I lose 15% that's tolerable given the cash I hold and leverage I can employ for a rebound.  


Nice article, that's what I'm talking about.  Quite a lot of concensus.  In my experience, and that I've stolen, too many people on the same side of the boat rarely leads to the expected outcome.


I think I was broad enough to cover what I think the range of most likely outcomes is in my opinion.  I'm not trying to be too precise at the macro level anyway.   


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