Stocks don’t feel safe, bonds no longer do either, but then again neither does moving into Dollars (or Euro’s) for that matter. Nothing feels safe, even George Soros hung up his cleats, what does that say for the rest of us! As anxiety wins the day, safety is sought, but safety is seemingly difficult to find. The debt ceiling debate has everyone on edge.
There is Risk in Getting out of Bed in the Morning
Today, people are of course reactive to fears that their “riskless” positions are anything but. How to insulate a portfolio from risk is a difficult question to answer, because in reality all investments carry risk, whether those risks are particularly visible or not. Individuals may feel as though there is no place to go for total safety except cash, but of course cash carries its own risks, doesn’t it? What would you say if I let you talk us into going to 100% cash, and then over the next week the Dow Jones rises 500 points? What of the person who felt it wasn’t safe to be in anything other than cash until unemployment rates moved below 8%. That may feel right, but in reality that means having moved to cash in February 2009, and remaining in cash today. At least Mr. Jones didn’t lose anything, right, there was no “risk”? Perhaps not visibly, but the market is up 77%, the US Dollar is down -16%, and his income stream over that time has been virtually nothing. There was, as it turns out, a great deal of opportunity risk in that decision, and no shortage of currency risk as it turns out as well. Cash, like any other financial decision, is only “riskless” to those who view such metrics with blinders on. There will always be risk, there are risks associated with getting out of bed in the morning after all, but our goal is simply to be a little better than most at identifying the risk levels of a decision – and thus being able to make sound decisions in relation to those levels.
Where Do You Get Your Panic?
For starters we don’t predict, we take one deep breath, two steps back, and add useful perspective.
For instance, the Dow Jones Industrial Average [DJIA] is up about 6% for the year, down about 1% since the beginning of July, and last quarter the Dow gained 0.77%. The NYSE Bullish Percent [BPNYSE] is in X’s at 58%, while the average S&P 500 component is 16% oversold on its weekly distribution. If we had to qualify all of those numbers with one word, we would probably not choose “panic” as the word to do so. The market has been digesting the debt ceiling issue for weeks, if not months, and yet none of these numbers reflect a great deal of panic, do they? So where then does the panic come from? Newspaper headlines, CNBC interviews, editorial columns, etc. perhaps, but the stock market has not yet reflected any panic. Will August 2nd be a bad day? Take solace in the fact that we are all human and lack the ability to predict the future with any regularity … embrace your humanity. If you want to see a bad day, think back to October 1987. On October 19th the Dow Jones dropped today’s equivalent of 2,713 points! Yes, in one day. Most of you reading this were probably not in the business then, but as a survivor of that day I can say, “been there, done that, lived to tell the story”. Did that move come out of nowhere? Did markets go from steadily rising to suddenly crashing on the August 2nd of it’s time? Of course not, the Dow Jones Industrial Average fell -11.2% in the one-month leading up to the Crash. The NYSE BP had formed a classic top (lower top with market indices hitting new highs) and moved to Bear Confirmed status at 50% by early October 1987.
Could these same indications be given again? Sure, you may recall a similar set of events back in 2007 in fact. The market moved to new highs in October 2007, the NYSE BP formed a lower top and moved Bear Confirmed in November and by January 2008 the Dow had fallen more than 10% from its highs and all things “equity” had fallen out of DALI. 2008 was unquestionably painful, but it did not come without warning.
Perspective, not Prediction
You don’t often know what a politician has told you even after he has said it, the market is generally far more honest. For politicians debating an elevation of the debt limit and what will come along with it, you can assume it’s going to be as much about getting votes as it is about market stability. My guess is they will, in the end, “save the day,” and raise the debt limit … but let’s not pretend to know what that means for the market even if it happens. We label it “Debt Ceiling” but isn’t it really a feeling of not understanding what is causing securities to gyrate up and down. What you need to know is that we have a plan … that we are monitoring risk and will make changes if the markets themselves change.
One visual that is very helpful is the Implied Volatility Distribution Curve of the S&P 100 (OEX), which shows that the market of stocks is now modestly on the oversold side of the ledger, which means that statistically the market is not materially overbought. The NYSE Bullish Percent is in X’s right now, a decline to 52% will signal trouble if it goes to O’s. DALI still suggests the strongest trend is town remains that of U.S. Equities over other asset classes.
Sell Down To Your Sleeping Level
Lastly, I would discuss an old market adage: “Sell Down To Your Sleeping Level”. Everyone is moderate, when things are going well they want all the upside, and conversely when things are going wrong they want none of the downside. This maybe a good time for us to reevaluate your true appropriate level of risk. This is the world we must live in.