This Rally Makes Me Sick to My Stomach – But I’m Done Fighting It

The bulls are running on Wall Street as a sharp shift in post-election market psychology has them chasing what they pray isn’t their own tails.  The Dow Jones Industrial Average rallied 3.06% last week to a near all-time high of 19756.85, stirring talk of Dow 20,000 by year end. The much broader S&P 500 also jumped 3.08% to a near-record 2259.53 while the Nasdaq Composite Index rose 3.59% to 5444.40.  Virtually every sector with the exception of bond-proxy utilities participated fully in the rally as investors acted as though President-elect Donald Trump has already made America great again.  If it were only that easy.

This rally has many of the earmarks of a blow-off driven by emotion rather than economic fundamentals.  Emotional rallies tend to move parabolically because they are ruled by the heart rather than the mind.  Think about your own emotions and you will understand this rally much better than if you try to rationalize it.  Emotions run at the edges and do not know moderation (if you do not have wildly strong feelings about your partner, for example, that person probably shouldn’t be your partner).  Feelings like love and anger are extreme, which is why they are difficult to control and tend to lead people to make poor (often tragically poor) life decisions.  The same is true when emotions affect investing.  The hardest thing to do as an investor is to resist your emotions.

I spent most of last week sick to my stomach because my head told me there was little economic rationale for the rally at the same time it told me there was a strong psychological and emotional basis for it to continue.  Unfortunately, since my hedge fund invests based on systems that remove emotions from the equation, we lost a little money (which made my stomach hurt worse because I am a perfectionist) but I’m disciplined enough not to override the systems but to take the pain.  But a market driven by emotions is bound to overshoot and that is what I expect to happen here. But until it does, I’m feeling pretty aggravated.  Then again, this should be the worst thing that ever happens to me, right?  Part of keeping emotional balance is learning how to maintain perspective.

And part of maintaining perspective is adjusting your strategy to make money no matter what happens.

So forget feelings.

As of today, I’m changing my gameplan…

I’m Adjusting My Strategy to Roll With The Rally…for Now

A legendary investor taught me that a broken clock is right twice a day, which means that it is wrong 99% of the time.  I may think the rally is unjustified by economic fundamentals but I am not prepared to fight it because the sentiment driving it is very real.  I share the relief that the toxic economic policies of the Obama administration are ending and will not have a chance to continue under Hillary Clinton.  Donald Trump is putting together an impressive Cabinet filled with businessmen and military leaders to replace the politicians and academics that served up eight years of progressive economic theories that suffocated the economy in high taxes and soul-crushing regulations.  The new regime gives the economy an excellent chance to grow faster and give all Americans – especially minorities and other disenfranchised groups whose votes are consistently betrayed by progressives – a chance to participate.

There is another potent reason why stocks are rallying in December – the expectation that taxes on investment gains will be lower next year.  In recent years, investors harvested gains in December on the expectation that future taxes would be higher in the future.  But with a Trump administration promising tax cuts, many investors are likely delaying stock sales until January and risking market declines until then.  While the market may shrug off next week’s almost certain 25 basis point interest rate hike by the Fed (unlike a year ago when the market sold off after the Fed hiked for the first time in a decade), tax selling may temper further gains in January.  We’ll have to wait and see.

But policy changes will not lead to an immediate economic boom and the market is borrowing gains from the future.  I would be cautious about chasing the broader market higher but I would definitely not short it. While I’ll still continue to short bad companies with rotten fundamentals, I’m broadening my strategy to include buying more good companies as well.

That’s right, I’ll be recommending a lot more long plays…starting this week.

If you’re a member of Zenith Trading Circle, you can go here now to get the first one I’ve released.

Don’t worry – I’ll also be giving Sure Money readers a look at some of these trades as they develop – though of course my specific recommendations are reserved for Zenith.

Long-Term, Rational Thinking Always Wins

Right now, we’re thinking rationally by acknowledging the real consequences emotions have on the market, and by tweaking our strategy accordingly. But we’ll also keep the bigger picture in mind (and that bigger picture still looks dismal).

Bond markets continued to sell off last week with the yield on the benchmark 10-year Treasury closing at 2.462% (it traded over 2.5% this morning).  Losses on bonds since the election of more than $2 trillion are greater than the reported $1.7 trillion of stock gains, which likely means that pensions and other institutions are no better off than they were before November 9.  I think it will take a 10-year yield over 3% to start seriously tempering stock market gains but again we will have to wait and see (remember that during the 2012-13 taper tantrum the 10-year yield got to just over 3% and we are a long way from there).

The US Dollar Index ended the week at 101.57, slightly below its recent high of 102.50.   The dollar was driven higher by the European Central Bank’s decision to extend but reduce further European bond purchases in its continuing but ultimately doomed efforts to prop up the moribund European economy.  The big surprise last week was that markets rallied after Italian voters rejected a constitutional reform referendum, leading to Prime Minister Renzi’s resignation and the likely ascendancy of the anti-EU Five Star party.  The fabric of the European Union is wearing thinner yet investors treated this important electoral defeat as a positive event, suggesting that disgust with the status quo – an emotional response – is overriding rational thought about the likely consequences if Italy were to leave the European Union.  Europe and the insolvent European banking system will remain a source of market instability in 2017 with important elections coming up in France and Germany and uncertainty surrounding the terms of Brexit.

On the company front, Sears Holdings, Inc. (SHLD) reported a horrible third quarter (no surprise) as it is increasingly looking like this may be the company’s last Christmas out of bankruptcy.  The stock ended the week down at $11.93, close to the bottom of its 52-week range of $10.50 to $22.42.  I will leave it to those smarter than I am to argue that Sears Chairman Eddie Lampert is playing a deeper game here.  From what I see, that game has taken Sears stock from $190 to $11.93 a share and is no “deeper” than the game that Bill Ackman was playing at Valeant Pharmaceuticals that took that company’s stock from $263 a share in August 2015 to its current price of around $15.00.  In fact, both games are so “deep” that I am confident in saying they will ultimately bury investors six feet under when the stocks go to zero.  Investors enamored with celebrity investors (which are defined as those anointed as geniuses by the sycophantic financial media led by CNBC) should heed the lessons of Sears and Valeant and apply them to Tesla Motors, Inc. (TSLA), another functionally insolvent company led by a P.T. Barnumesque entrepreneur who tweets out incessant promises he can’t keep and whose balance sheet is a nuclear waste site that is likely to detonate by the end of 2017 (unless he wakes up an sells a boatload of stock while it’s still trading at close to a ridiculous $200 per share).  While the stock market is going up, there remain many companies that can’t keep their promises and these three are at the top of the list as we are reminded when they are forced to come out from behind the curtain and report their abysmally horrible financial results every quarter.

There are no shortage of opportunities to make money on both sides of the market by focusing on the facts and leaving emotions behind…and we’re going to keep right on doing that.

Sincerely,

Michael

19 Responses to “This Rally Makes Me Sick to My Stomach – But I’m Done Fighting It”

  1. I am thoroughly disappointed with all you gloom and doomers. I agree with just about everything you say, and maybe that’s the problem. Maybe we are being emotional. I now realize that “when” is a very important consideration. Sure the market will crash someday, but when? I’m becoming a trend follower instead.

  2. I must admit that I am also shocked that the stock market didn’t crash after the Italian vote last week and certainly do not understand the current market rally but I still am very suspicious as to how long this bubble is going to inflate before it pops. One thing I’ve noticed from history is that if not the investors then the stock market in general loves milestones. The Dow is approaching the 20k milestone. In the past after milestones have been reached and all of the hoopla has been celebrated reality starts to set in and the crash follows. I would go with the flow for now but protect yourself with stops and trails as we approach the 20k milestone because if the anticipated bubble burst is to happen at all there would not be a better time then right after we reach that 20k milestone. Be careful and be safe!

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