Goodbye August, and not a moment too soon. The volatility demonstrated for the month was astounding: out of the 23 days the markets were open, the Dow Jones Industrial Average moved by triple digits (either up or down) 16 of those days. The best single day was a gain of +3.98%, and the worst day was a loss of -5.55%. August will definitely go down as one of the most volatile, unpredictable, and treacherous EVER. Now on to September.
The reason for the volatility can be summed up in one word: fear. Fear that the economy is slowing down again, fear that the Fed won’t come through with yet another massive stimulus effort, fear that if they do stimulate the economy traders may be left behind and miss their year-end bonus for not beating the markets. To be blunt, the markets are a mess but they’re in relief rally mode right now for all the wrong reasons. Every piece of economic data shows a weakening economy: contracting manufacturing, dismal consumer sentiment, rising unemployment, plummeting interest rates, falling home prices. But none of that matters because the Federal Reserve has opened up the door for yet another intervention. And day traders and hedge funds and high speed computer traders are scared to death that they’re going to be caught on the wrong side of the market if Ben Bernanke comes through yet again. “Don’t fight the Fed” is an age-old investor’s adage. To be sure, they can still wield a really big stick. But ultimately letting the markets dictate fiscal policy is a very very bad idea.
Two weeks ago, every investor I spoke with wanted nothing to do with the markets. Understandable, given the swift downdraft after the S&P triple-A downgrade, the last minute debt ceiling non-solution (punt), and severe economic weakness overseas. Investor sentiment notwithstanding, we executed our sell discipline on schedule – working our way out of the markets as planned. For a few days, we were solidly ahead of the markets. Now, we’re behind. Our strategy to intervene during volatile and unpredictable markets has always produced the exact same result: great stability in the short run. Unfortunately, we’re just not participating in much (if any) of the current relief rally.
And here’s a really good reason not to chase the markets too hard right now: relief rallies rarely end well. During the two previous bear markets of this decade, you may be surprised to know that the markets rallied mightily twice within the context of sharp downward trends. The first relief rally started in April of 2001 in the midst of the dot-com blowup, pushing the markets higher by a solid +14.45%. Everyone thought it was the end of the bear market, but the downturn finally ended 16 months later after dropping a whopping 37.95% after the rally faded.
Case number 2: in the early stages of the real estate and credit blowup in March of 2008, the markets rallied by +10.21% over a five week period. 10 months later the market finally bottomed after falling an additional -52.07% once that relief rally faded! How strong has the current relief rally been? Well as of 9:00 AM today, the S&P 500 has bounced 9.56% off of its low. Strong, but not as strong as either of the two rallies mentioned above that both failed to hold. One of my clients asked me yesterday if the current relief rally was an example of a bull market kicking and screaming its way out the door. I can’t think of a more perfect example.
When you miss your train, you don’t start running down the tracks after it like a wild man; you simply wait patiently for the next one. Right now, we’re actually not too far away from replacing a few half positions dictated by our discipline. We continue to hold a half position in real estate, and it appears more likely that it will hold. Our bear market and other defensive positions have been drags on our portfolios lately, and we’ve covered many of those to avoid becoming too defensive. We continue to implement our discipline as always, and we’re very much aware that these unpredictable markets are a constant source of stress for everyone. It is likely that we’ll get quite a bit more clarity in the coming few weeks.