Easy Money
Posted on Sunday, November 11th, 2018
Clients are asking what happens next and what do we do about it? Here are some excerpts from an interview Howard Marks did last month on his book tour. I believe it explains the process and what to do next very well.
What can investors do to make better investment decisions?
…you have to have a sense for where the market stands in its cycle. That’s what’s determines the odds. When the market is attractively positioned, low in its cycle, then the expected return is above average, and you want to play offense. In contrast to that, when the market is unattractively positioned, high in its cycle, then the expected return is below average, and you want to play defense.
What’s the temperature of the market right now?
I believe we are high in the cycle. For instance, P/E ratios on stocks are above average. They are not as crazy as they were in 2000, but they are above average. Also, interest rates on bonds are below average, yield spreads are at historic lows and credit conditions are weak in terms of looser covenants. What’s more, we are in the tenth year of an economic recovery and there has never been a recovery of more than ten years. That doesn’t mean this recovery can’t continue, and frankly, it feels like this one will go more than ten years.
What does this mean for investors?
The longer the cycle has gone up, the closer we probably are to the point when it turns down. We’re in the tenth year of a bull market and the S&P 500 has quadrupled from the low of March 2009. That’s why I would argue that the easy money has been made. The market environment is not as attractive as it was ten years or five years ago, and that means the chances of extreme positive performance are low. So given where we are in the cycle and what has happened, you can’t argue that we should take on more risk today than we did five years ago.
So I don’t think there is going to be some disastrous crash. But the experience just will not be a good one.
In my view, market conditions make this a time for caution, a period more for defense than offense. More defense means more bonds than stocks, high quality stocks rather than low, big companies rather than small ones, value strategies rather than growth strategies, stable companies rather than cyclicals, developed world rather than emerging markets.
There are ways to insulate your portfolio rather than jumping completely out of the market. We don’t know when the economy or the market will sputter but we know that valuations have become stretched and we are working on one of the longest expansions on record. The easy money has been made. If the market keeps going up, we are still invested and making money – just a bit more defensively. If it goes down, by holding US large cap value with a healthy dose of bonds, we will lose less and be in a better position to take advantage of any drop in prices.
Oil is now down 20% for the month! That is a huge move. Oil started lower on the same day that Powell made his comments back on October 3rd. Stocks and oil prices tend to move together. We suspect that the headwinds to growth and the stock market are growing.
As we said last week, there had been hope that Powell and friends would back off their plan for higher rates but the wage gains and now the latest FOMC statement make it look like they are committed to higher rates for now. The end result is that we expect to see higher rates for longer and that will put pressure on stocks.
We have noted that are stuck in a very large trading range and that range stretches from 2550 – 2880 on the S&P 500. The S&P closed on Friday at 2781. We have retraced half of the down move from October. As the selloff progressed it was obvious that the market had gotten over sold and was due for a bounce but the question was how high would it bounce? Investors always look for a bounce which regains half of the move down. Investors also look to the 200 DMA as the dividing line between a bull market and bear market. We have retraced half the down move. We are also just above the 200 DMA which all of the computers will be keyed on. Investors will now be watching these levels very closely to see who wins out – the bear or the bulls. It looks to be an important week.
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.