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Dream Theme 2013: Rebalance

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Markets seem to defy the Law of Gravity. I remember a 1993 movie titled Fearless about a guy who felt invincible after a near-death experience, only for depression to set in.

Markets faced near death in 2008 too after deftly sidestepping the worst case scenario, but there was a silver lining.

Threats of the EU’s collapse, government austerity and tax policies, contentious debt ceilings debates –to name a few crises—lull investors into complacency. They put their guard down and rediscover their appetite. If so, then it’s time to worry.

Investors tend to have a glass is half full mindset.

This is why they find US stocks enticing compared to Europe. This is why they are on a tear thanks to major corporations geared towards providing products and services to Asia, which is less affected by financial turmoil.

Weak US GDP growth, even if spiked with optimism, should reflect weak equity market valuation. With bright hopes for a recovery, the bull markets have stampeded rational sensibilities and outran all fair valuation parameters by wide margins. How wide? Depends on metrics. If we use cyclically adjusted price earning ratio that averages earnings over a 10- year period, this long term valuation yardstick reveals 22.9 which is 39% above the long term average. If we use Q ratio which compares replacement costs of net assets, US equities is 50% overpriced. Uh-oh...time to crunch numbers.

Cash is looking for a home. The need for a safe haven has been replaced by a desire for high risk/high return assets in the form of equity.

A low interest regime means cash will yield microscopic yields. Bond yields are unattractive. Gold is at near all time high, thus, limited gain upside to a non-yield generating asset.

Modern economics uses its own performance enhancing drugs. It’s called quantitative easing, stimulus injections, and low interest.

They do provide a temporary high and mask the pain but these things usually fade. We all end up back to reality. Back to confusion, depression, and other side effects once the effects wear off.

No one can tell what the morrow shall bring. What more the next 12 months?

Mergers and acquisitions boost prices. A housing rally pumps confidence. Surprise earnings reports work like an adrenaline rush.

I’m keeping my own forecasts close to my chest because markets are behaving beyond rational territory. One can be right then lose money or opportunity and be wrong then reap a bundle. This makes guess work an impossible and thankless job.

My Two Cents
Many believe it’s better to win by being wrong than lose by being right.

Or it’s better to be lucky than smart.

I think I agree but upon reflection, charting the middle path between the two seems wiser.

To those fully invested, maybe it’s time to re-balance. Take profit and wait for the inevitable correction to get back by finding value.

To the bystanders, it pays to have the patience of a monk waiting for markets to correct.

Print ed: 04/13


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