The INVESTMENT STRATEGY LETTER
Looking for a Top in the Stock Market/OR/It is OK to be Bearish

While I was having lunch today with a business associate (thanks for lunch) and talking about this blog, I mentioned how much easier it is now, to be bearish and warning about a possible new Bear Market, when you don’t have to worry about panicking your clients. It is one thing to write a philosophical blog (just for the fun of it) and it is quite another to have the fiduciary responsibility of clients on your hands. Therefore, I feel much more at ease, talking about a top in the stock market, than would a money manager. Besides, for those who have a fiduciary responsibility, ‘market timing’, is frowned upon by such regulatory entities as the SEC and FINRA.
The financial industry approves of the Efficient Market Hypothesis Theory (EMHT), which proposes that it is impossible to beat the market by trading in it out and that investors should at all times be fully invested in the market in the aggregate, by owning an allocation of mutual funds, because in the long run the market will go up. The dangerous beauty of this theory is that accordingly, your goals will always be achieved sometime in the future. If you just ‘hang in there’ long enough you will make your money back. This gives investors a false theory of contentment. However, during a very long period between 1997 and 2012, the market was up 50% of the time and down 50% of the time. Also during that period there were two stock market collapses of 50%, one between 2000 and 2003 and the other between 2008 and 2009. The financial industry would have you believe that trying a methodology that uses market timing is an ‘heretical tactic’. Lately, the EMHT methodology, has investors drinking euphorically from the common Kool-Aid trough.

Bear markets do not offer the average investor in mutual funds many alternatives to protecting their portfolio in a Bear Market. Professional investors  easily go short or long with ease. For instance, while Goldman Sachs was selling worthless mortgage-backed securities to Iceland and Ireland, they were shorting the same securities in their own portfolios. It is human nature for most investors to be positive and patriotic and therefore to be bullish. We want the market to go up because it is in our general best interests that the economy prospers, so that our careers and our families can prosper. At one time I use the word ‘good;, when the stock market broke out on the upside and ‘bad’ when a breakout occurred on the downside. This is a bad habit, that we as investors have to break. The outcome for us is only ‘good’ if we are long the security, when the market  goes up or short a security when it goes down. There is a misconception among most investors that they can only make money, if the market goes up. With the use of options, such as puts and the ability to go short a stock as easily as you can go long, investors no longer have to rely solely on mutual funds.

John Maynard Keynes said “markets can stay irrational longer than we can stay solvent.So,”Don’t be stubborn. If the market is topping ,don’t just ‘hang in there’ Your investment decisions have nothing to do with being positive or patriotic.We do not control world events, the economy or the markets. However, we do control our attitude and we can change our old investment habits and follow a strategy of being more flexible.

Be as a cold hearted money player, just as the professionals are. What did the mobster say to his victim in the movie Godfather just before he killed him? “Sorry it’s only business.” That does not mean to be cold hearted in your personnel life. Just making a killing won’t make you happy and the money won’t last long, unless you are in the right frame of mind to be deserving of receiving abundance.

I think tomorrow’s subject will be about five indicators that are showing red flags for a stock market top. For instance, did you know that investor sentiment for people who are bearish is at a nine year low whereas those who are bullish are at a new high? That Kool-Aid flavor of euphoria, sure tastes good.

Carl M. Birkelbach 11/13/14