Waiting for the Hundred Minute Flood

November 29, 2010 at 1:09 am 3 comments

Investors have been scarred over the last decade and many retirees have seen massive setbacks to their retirement plans. We have witnessed the proverbial “100 year flood” twice in the 2000s in the shape of a bursting technology and credit bubble in 2000 and 2008, respectively. The instantaneous transmission of data around the globe, facilitated by 24/7 news cycles and non-stop internet access, has only accelerated investor panic attacks – the 100 year flood is now expected every 100 minutes.

If drowning in the 100 year flood of events surrounding Bear Stearns, Lehman Brothers, Washington Mutual, AIG, Fannie Mae, Freddie Mac, TARP bank bailouts, Bernie Madoff’s Ponzi scheme, and Eliot Spitzer’s prostitute appreciation activities were not enough in 2008, investors (and many bearish bloggers) have been left facing the challenge of reconciling an +80% move in the S&P 500 index and +100% move in the NASDAQ index with the following outcomes (through the bulk of 2009 and 2010):

  • Flash crash, high frequency traders, and “dark pools”
  • GM and Chrysler’s bankruptcies
  • Dubai debt crisis
  • Goldman Sachs – John Paulson hearings
  • Tiger Woods cheating scandal
  • Greece bailout
  • BP oil spill
  • Healthcare reform
  • China real estate bubble concerns
  • Congressional leadership changes
  • European austerity riots
  • North Korea – South Korea provocations
  • Insider trading raids
  • Ireland bailout
  • Next: ?????

With all this dreadful news, how in the heck have the equity markets about doubled from the lows of last year? The “Zombie Bears,” as Barry Ritholtz at The Big Picture has affectionately coined, would have you believe this is merely a dead-cat bounce in a longer-term bear-market. Never mind the five consecutive quarters of GDP growth, the 10 consecutive months of private job creation, or the record 2010 projected profits, the Zombie Bears attribute this fleeting rebound to temporary stimulus, short-term inventory rebuild, and unsustainable printing press activity by Federal Reserve Chairman Ben Bernanke.

Perhaps the Zombie Bears will change their mind once the markets advance another 25-30%? Regardless of the market action, individual investors have taken the pessimism bait and continue to hide in their caves. This strategy makes sense for wealthy retirees with adequate resources, but for the vast majority of Americans, earning next to nothing on their nest egg in cash and overpriced Treasuries isn’t going to help much in achieving your retirement goals. Unless of course, you like working  as a greeter at Wal-Mart in your 80s and eating mac & cheese for breakfast, lunch, and dinner.

This Time is Different

The Zombies would also have you believe this time is different, or in other words, historical economic cycles do not apply to the recent recession. I’ll stick with French novelist Alphonse Karr (1808-1890) who famously stated, “The more things change, the more things stay the same.”

As you can see from the data below, the recent recession lasted two months longer than the 16 month cycle average from 1854 – 2009. We have had 33 recessions and 33 recoveries, so I am going to go out on a limb and say this time will not be any different. Could we have a double dip recession? Sure, but odds are on our side for an average five year expansion, not the 18 month expansion experienced thus far.

The Grandma Sentiment Indicator

I love all these sentiment indicators, surveys, and various ratios that constantly get thrown around the blogosphere because it is never difficult to choose one matching a specific investment thesis. Strategists urge us to follow the actions of the “smart money” and do the opposite (like George Costanza) when looking at the “dumb money” indicators. The bears would also have you believe the world is coming to an end if you look at the current put/call data (see Smart Money Prepares for Sell Off). Instead, I choose to listen to my grandma, who has wisely reminded me that actions speak louder than words. Right now, those actions are screaming pure, unadulterated fear – a positive contrarian dynamic.

Over the last few years there has been more than $250 billion in equity outflows according to data from the Investment Company Institute (ICI). Bond funds on the other hand have taken in an unprecedented $376 billion in 2009 and about another $216 billion in 2010 through August.

As investment guru Sir John Templeton famously stated, “Bull markets are born on pessimism and they grow on skepticism, mature on optimism, and die on euphoria.” Judging by the asset outflows, I would say we haven’t quite reached the euphoria phase quite yet. I won’t complain though because the more fear out there, the more opportunity for me and my investors.

As I have consistently stated, I have no clue what equity markets are going to do over the next six to twelve months, nor does my bottom-up philosophy rely upon making market forecasts to succeed. Evaluating investor sentiment and timing economic cycles are difficult skills to master, but judging by the panicked actions and bond heavy asset inflows, investors are nervously awaiting another 100 year flood to occur in the next hundred minutes.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, WMT, and AIG derivative security, but at the time of publishing SCM had no direct position in Bear Stearns, Lehman Brothers, JPM, Washington Mutual, Fannie Mae, Freddie Mac, GS, BP, GM, Chrysler, and any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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3 Comments Add your own

  • 1. sidoxia  |  November 30, 2010 at 8:02 pm

    Relevant quote on worrying too much:

    “We can predict 10 of the next two recessions.” –Seth Klarman

    Reply
    • 2. sidoxia  |  November 30, 2010 at 8:05 pm

      Here’s another:

      “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

      -Peter Lynch

      Reply
  • 3. Weekend reading: Renters and rentiers  |  December 4, 2010 at 4:33 am

    […] Waiting for the 100-year flood – Investing Caffeine […]

    Reply

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