Ride the Wave
Posted on Sunday, December 6th, 2020
It has finally gotten cold here in Georgia. After all these years of being a miser I broke this week. I have caved in and finally turned the heat up at the Reilly house. Sweatshirts. Blankets. Heaters. Enough. My northern blood has turned southern. Even the dog has been curling up with a blanket. Life is too short to be freezing in my own home. This may not be permanent. Wait until I see the bill!
After such a great month we would expect to give some of those returns back to the market but retail driven flows do not want to have any of that and a Merry Christmas is expected by all. The news surrounding the market seems to be all positive. (Even the bad news is positive because bad news just means more support from the central banks.) The latest news of vaccines being distributed early next year has helped further buoy markets. The CNN Fear and Greed Index is doing a good job of providing a synopsis of the current state of the market as it sits at 89 and is still in the Extreme Greed category. This is usually where you find that I become a contrarian to the market and the masses but the end of the year is historically a very good time for market returns and I expect more of the same until we turn the calendar.
The bottom line is that markets have never been this expensive on almost all valuation measures. Along with those sky high valuations sentiment is now appearing stretched. Call buying is at all time high. ALL TIME! The small investor is pushing this market higher and with leverage. That usually ends poorly and sharply. But it’s the holidays and people are home at their computer trying to trade for a few extra bucks to pay Santa. While stocks are up and everyone appears “all in” stocks can still head higher especially amidst the joy of Christmas and the New Year. The old saw is that stocks can stay irrational longer than you can bet against them. Leading the charge higher are the most shorted stocks. Shorted stocks have investors betting that they will go down and those traders are losing that bet and are being forced to buy at ever higher prices. Large short positions in the market are good for the market. That serves as support for stocks when they go down as short sellers then buy that stock back. Right now short sellers are becoming extinct. The current environment is like the guys at the circus removing the net while we are up on the high wire. I am not saying that stocks are about to fall but when we do it is going to hurt all that much more and we will fall at some point.
Being in the highest quartile of valuations we would expect that returns would be in the lowest quartile with larger than normal and more frequent bouts of volatility. While our recent portfolio construction has less equity positioning and more cash than I would like I am willing to except that with the commiserate trade off and reduction in risk. Our 3 and 5 year time period returns are still hugging our benchmarks and taking the long view seems to be the prudent approach. So, for now, we still participate in the upside, albeit a little less so. The day will come that markets underperform and at these valuations that underperformance will, most likely, come in quick volatile bursts and I expect that, much like 2020, a dynamic and strategic allocation to stocks will be the key to portfolio performance in 2021. For now we ride the wave higher but we are ever ready to brace for impact.
Stay safe.
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
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
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.