"Don't let your special character and values, the secret that you know and no one else does, the truth -- don't let that get swallowed up by the great chewing complacency." -- Aesop (620 - 560 BC)
Time breeds complacency in the minds of fools: Eventually, the same human flaws will lure us into believing that "everything is OK" just before things turn for the worse. Investors still appear to be looking for reasons to get in or stay in stocks while shrugging off negative news as opposed to exercising warranted caution. I find it concerning, yet not surprising, that investor sentiment is solidly positive again so soon after a significant market correction with increasing evidence of a weakening economy.
Mass investor interpretation of "Fed Speak" on March 21 was that the "bias" for the economy has shifted to neutral, opening the door for possible rate cuts in the future. Investors responded with a sigh of relief from worries over the housing sector and sub-prime mortgage industry by pouring money into stocks. (Note: the ratio of winners to losers was 9 to 1 -- a rare occurrence). The proper interpretation of the Fed's recent shift in bias is that signs of an economic slowdown are becoming more evident; otherwise, there would be little reason to lower rates.
I began this post a few days ago when I read news of record mutual fund inflows and record margin debt -- both signs that have historically marked the end of Bull Markets. I decided to wait until after the Fed meeting for more evidence to complete my post...
The forecast is still a little cloudy for 2007 but a "storm of irrational exuberance" is gathering now. January and February reportedly brought record inflows to stock mutual funds. What's more, Margin debt, when investors borrow money from a brokerage firm to buy stocks, has also reached record highs. While we may not quite be at the "irrational" level now, history shows that the end of each Bull Market is marked by investor euphoria. The last time we saw records for fund inflows and Margin debt was the year, 2000, the beginning of the last market meltdown...
You may have heard me say that "history does not repeat, but it does rhyme..."
Like the weather, the very nature of financial markets is that its behavior is not possible to predict with consistent accuracy; however, it is possible to see "the storm" coming by knowing and respecting history. Where precision and accuracy are limited, with the weather and financial markets alike, is knowing precisely where and when the storm will hit. By the time these two crucial items are known in absolute terms, the storm has already come and gone. This is why it is not logical to try for pinpoint accuracy in our "forecast" or even concern ourselves with the small "storms" but to look at the big picture of probabilities and strategically plan ahead for the "big storms..."
Now let's tie all of this together for some philosophical meaning and perspective: If we know and respect history, wisdom dictates that we should be prepared well in advance of the storm's arrival. At the same time, it is unnecessary to "evacuate" before signs of the storm are even present. Living on the beautiful coast of South Carolina, I am well aware that hurricanes are seasonal. The economy and financial markets are cyclical. The similarity here is that seasons and cycles are identifiable. Clearly, our economy is in the latter stages of its cycle, which means recession is the next stage...
Weathering the storm is dependant on our actions before it arrives. As with financial markets today, it would be prudent to strategically prepare for the next Bear Market before the masses begin to move; however, selling out of the market completely now would be foolish for a long-term investor. The challenge for prudent investors lies somewhere between participating in the market's current positive momentum while simultaneously preparing for the storm ahead...
With that in mind, I'll repeat what I've been saying since late 2006: I believe 2007 is the year to slowly shift to the defensive by decreasing speculative positions (small-cap, emerging markets, heavy sector bets) and increasing less speculative and defensive positions (large-cap stock, multi-sector bond, health care). Since the market is close to where it began the year, now is as good a time as any to strategically position your portfolio.
Balancing the risks and rewards of this current market are becoming increasingly difficult, to say the least. Please be sure to check out my "Where To Invest 2007" posts for more logical investment "philosophy." It should also go without saying that leveraging the wisdom of others by hiring a "fee-only" investment advisor may be in your best interests as well -- but that's another post...
TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston. ACI specializes in retirement, investments, and comprehensive financial planning.
Comments