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Resisting the Horn of Doom

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23

June 13, 2014 – Comments (7)

Board: HG Philosophy

Author: ChanceEldrDancer

[The following is from our premium service Motley Fool Hidden Gems. Click here to take a no-risk free thirty day trial.]

It is hard in a long post to continually say “IMO” and do all the usual caveats. Please understand that this post just presents my point of view; I truly respect yours as well, and I understand and quite honestly believe that what is right for me may not be right for you. All of this is IMO!

John Hussman has been sounding the horn of doom for years now, and anyone who had paid attention back when he started to do so would have missed out on very large gains in the market. With that caveat, I still think it is worth pondering his latest essay:

June 9, 2014
We Learn From History That We Do Not Learn From History
John P. Hussman, Ph.D.


http://www.hussmanfunds.com/wmc/wmc140609.htm

I would like to direct your attention to three ideas:

1. Markets go in cycles, and the day will come when we once again have a bear market.

This is not controversial at all; it is purely a matter of when, not if. But “when” is critical – unfortunately, no one seems to have a crystal ball.

2. We forget how terrible a bear market can be, and how hard it is to resist the urge to panic.

Everybody talks a good game when times are good. As we hum along to ever-higher new highs, we occasionally have a 2% dip and all the brave souls throughout Fooldom all spout the same tired, hackneyed phrase: “Be greedy when others are fearful . . . “ and purchase stocks with relish, proud of their savvy and fortitude.

Yes, we are all analytical, resolute and tough when we get the hiccups – but how about when the smallpox epidemic hits? I guarantee you, right now, that most of our tight-lipped Clint Eastwood types will turn into screaming nervous Nellies when the real thing rolls around – and it will, someday.

I think it is a very good exercise to remember what a bear market actually feels like, and to try to imagine how we will react when it comes. Here is Hussman:

On the subject of risk tolerance, recall that a typical, run-of-the-mill cyclical bear in the stock market comprises a loss of about 32% (though the most recent bear markets have been far worse).

OK, tough guys and gals, think about that. Your $200,000 account will suddenly have lost $64,000 – even though you did everything right. You followed the rules, you stayed the course – and your $200,000 has turned into $136,000! And it is sinking like a stone! Is this the end? Can you endure another huge drop? Should you sell? Your whole life is in jeopardy – the kids’ college funds, the retirement plan . . . .

Back to Hussman:

Remember also how compounding works. A 32% loss turns a 100% gain into a 36% gain. The 55% market loss in 2007-2009 was equivalent to an initial 25% loss, followed immediately by an additional loss of 40% from there. At market peaks, investors easily forget the extent to which bull market gains are erased over the completion of the typical cycle.

My advice to you, my friends-of-the-boards, is to avoid over-rating yourselves, as I am trying to do. Do not assume you are different than everybody else and can easily withstand the pressures of a bear market. Envision how it will feel, understand how hard it will be, and prepare yourself now for those emotions.

Hussman goes on:

A reminder: The first sell-off in the typical bear market averages 10-12%. By that point, investors often feel that stocks have declined too far to sell, and are heartened by the partial recovery that typically follows. The same sequence generally repeats many times over, with one or two much deeper free-falls along the way. . . . .

Regardless of whether the market’s losses in this cycle turn out to be closer to 32% (which is the average run-of-the-mill bear market loss) or greater than 50% (which would be required to take historically reliable valuation measures to historical norms, though most bear markets have continued to undervalued levels), it’s going to be difficult to avoid steep losses without a plan of action.


Yes, one very acceptable plan of action – one even endorsed by Hussman -- is to be IN FACT a resolute buy and hold investor. Weather the storm, take your hit, stay fully invested, do not panic and sell, and over time the next cycle will do its magic and you will be OK. Of course this may take ten or more years, which is why you need to have cash reserves sufficient for your circumstances.

A large problem with this approach is that most people overrate themselves; they think they are tougher than they are. And, when things are darkest, and terror is very real, and it seems as if there is no bottom in sight, no end to the losses – these people sell, ensuring that the disaster is permanent.

Be honest with yourself: are you that weak-kneed person? I am pretty sure that I am. I have been through a few of these and I have not done very well. I panic and sell – I know I should not, but the storm just goes on and on and on and it seems that it will never end, and sooner or later I say to myself, “Holy Bleep, I have got to get out and save something; I will reinvest when the market has lost another 20%!!”

You know how that turns out.

3. If you cannot ride out the storm, prepare yourself now for a different approach: panic early, while the exit doors are not crowded and the damage has not occurred.

Wow, this is radically unpopular advice in the MF universe. Here we are, sitting in the horn of plenty, gobbling down grapes and persimmons and those little hot dogs wrapped in soggy bacon, and swilling down flagons of Coca Cola, basically having a great time while slowly killing ourselves at a nutritional level – and this idiot over in the corner is saying, “RUN FOR THE EXITS!! FIRE ON THE MOUNTAIN!!THE HYKSOS ARE HERE!!!”

And I admit it; I am doing exactly that, as is the brilliant, estimable and perpetually wrong Hussman. I am sitting on huge gains; my accounts are larger than I ever dreamed they would be (since I am a horrible investor), and I am just fine with where they are. I would have been happy to reach these levels by 2020, if you had asked me four years ago.

And as I query myself about how I will do when a bear market hits, I realize I will fold like a cheap tent. I will hold and hold and hold, following the well-meaning exhortations of everyone here, until the very darkest days, when I will sell in utter panic.

So, forget that; I do not like that future. I like a different future -- the one where I (i) go over my holdings with a very critical eye, selling everything that will look unappealing to me if it sinks like a stone in a market decline, (ii) sell enough of everything else so that I am 50% in cash, (iii) sell all my big losers, no matter what, to generate tax losses to cover some of the gains from the other sales(after all, if they are losers in this market, what hope do they have in a bear market?), and (iv) put on a hedge covering half of my remaining market exposure (in my case a short of SPXL).

I know this is not optimal, but I actually could care less -- I can sleep comfortably through any likely future, including one where I miss massive additional gains, and I know that I am avoiding the doom that almost certainly awaits if I try the MF way through a real bear market.

Hussman says:

In our view, that [plan of] action should be rather immediate even if the market’s losses are not. However uncomfortable it might be in the shorter-term, the historical evidence suggests that once overvalued, overbought, overbullish conditions become as extreme as they are today, it’s advisable to panic before everyone else does.

BTW, here are the big losers that I sold; I will evaluate repurchasing them in 30 days:

AWAY
BBSI
CALL
CHUY
MTY (Toronto ticker)
NGVC
RGR
SLW

Any thoughts on the merits of these stocks at these (relatively) depressed prices?

Rich


CED 

7 Comments – Post Your Own

#1) On June 13, 2014 at 2:14 PM, Mega (99.96) wrote:

I think selling all of those was a good idea. Not because of market risk, because there are better stocks to own.

Hussman is a smart guy and a good writer. But his paranoia about market risk is just a little past the point of rationality.

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#2) On June 15, 2014 at 7:51 PM, awallejr (83.96) wrote:

I already passed the test.  I survived 2008-2009.  I was staying holding, but the problem was I was holding crap (thank you Cramer).  Once I realized the only person to listen to was Bernanke I rolled what remained of my portfolio into mlps, bdcs, and reits.  The yield generated helped a lot as well as my selectively selling puts.

I look at my portfolio and briefly think maybe I should liquidate.  But then I think where to put the cash.  And right now the only answer I have is in the stocks I own.

As for your picks I would stay away.  Get yourself some yield.  Yield helps surviving corrections.  It gives you monthly cash to use to take advantage of dips. Selling puts does too:

http://caps.fool.com/Blogs/put-sales-2014-continued/966456

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#3) On June 16, 2014 at 3:34 PM, EnigmaDude (94.14) wrote:

Of the stocks on your list I think NGVC is worth considering. They still have plenty of opportunity for growth and the people who like their stores generally prefer to shop there as opposed to Whole Foods or other "natural" grocers.

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#4) On June 17, 2014 at 10:34 AM, aleax (50.35) wrote:

Hi CED, you know I'll sharply disagree on RGR -- at a below-11 P/E (ridiculously low PEG) and a 3.68% yield, you'd have to pry it out of my cold, dead hands:-).  If it was a big loser for you I deduce you must have bought around year-end -- it was never above 60 before September 2013, and it's above 60 now.  Me, I'm a long-term holder so it's way a multi-bagger for me -- and a long-term keeper.

That's problem #1 with "sell your losers" advice: what's a loser depends on your cost basis, thus on when exactly you established and accumulated... and the market doesn't know or care about such personal timing issues.  I find it preferable to focus on the fundamentals, which I find totally fine for RGR, with their new factory getting up to speed and their continually-improved product line as shiny as ever...

 

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#5) On June 17, 2014 at 12:00 PM, MrMighty (36.95) wrote:

I agree about reviewing your stocks, but I think you should be doing that anyway.  I periodically look over my holdings, remind myself why I bought them, and ask myself if that rationale still holds.  I stayed 100% invested through 2007 and beyond, but my holdings did change sometimes as the fundamentals for some of those stocks changed.  I continued to make my regular contributions to my retirement fund, 100% in stock as well, and came through the other side in pretty good shape. 

That experience will stand me in good stead during the next correction.

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#6) On June 19, 2014 at 3:42 AM, BogdanBB (< 20) wrote:

 I saw ALPC, they announced a change of business into cloud computing and online television.  If it trades below $1 I will probably go for it

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#7) On June 29, 2014 at 5:17 PM, TMFTailwind (52.73) wrote:

I am bullish on AWAY. I am generally bullish on leading online properties in general (AMZN, EBAY, TRIP, PCLN, YELP, etc).

There tends to be a winner-take-all or winner-take-most dynamic with these types of companies, due to a network effect with a positive feedback loop. There tends to be one or two comapnies where there is the most ________ (information, affiliated businesses, selection, etc), and consumers gravitate there due to that attribute. Then, as more consumers gravitate, the network becomes even stronger due to their contributions. In addition, these online businesses generally benefit from the tailwind of continued migration to online and mobile information and services. And finally, these types of businesses tend to look much more expensive than they actually are due to heavy investment in growth that lowers GAAP earnings.

I think AWAY has the potential to become one of those leading online properties. The company is growing its web traffic and listings at impressive rates through a combination of acquisitions and marketing, and that growth reinforces the value proposition to consumers and grows the earnings power of the business. Finally, as the global economy continues to grow and emerging market countries become more wealthy, more and more people will be in the market for leisure travel.

It's a company I have my eye on (I have an active written put position - Oct 14 puts with a $28 strike) and I think it has the potential to be worth much more in 5-10 years. Even though the stock is up to $34 from $30 since you wrote this, I still think the stock could be a compelling value so long as the online and leisure travel markets maintain their current pace (or just so long as we don't see another major global recession).

My 2 cents,

Billy 

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