Fortunately for those of us willing to climb the proverbial and very real Wall of Worry, many (most?) investors continue to cling to their belief that this rally is a head-fake, that the country is headed to hell in a hand basket, and that "this time it's worse than ever before." I hear from them all the time when they tell me what an idiot I am after reading my articles on Seeking Alpha, ForexPro, GuruFocus or elsewhere.
As I wrote to a brilliant investor friend who was concerned that the institutional manipulation by Wall Street makes this time different, a viewpoint I didn't touch on in last month's issue: "It's true that HFT, program trading, dark pools, et al are new ways Wall Street has come up with to avoid transparency and middle the very people they claim to be on the same side as. But thus has it always been. Back in the 1920s it was bald-faced manipulation via "trust" companies, in the 1960s it was the crooked specialist system -- put in a trailing stop 2 points away and the stock would magically decline 2 points for one trade then magically recover by 1.98 with the next trade. We should always expect double-dealing from Wall Street.
"I don't know, but my guess is that the average holding period for the 76% of trading today dominated by institutions may be closer to 5 seconds, factoring in the millions daily that last a millisecond as well as the pension funds that hold for 6 months.
"But I really don't care. I don't have to compete with them, and I don'tcompete with them. While they are making millions of trades to make a sure penny each trade, I am buying quality under-loved companies too thinly traded, foreign or boring for them to bother with. My holding period may be 6 months, a year, or much longer. They can keep their approach; there is a whole universe of companies it isn't worth their while to manipulate or in which they might get caught on the wrong side and lose all their other ill-gotten gains.
"I'll still fight to get appropriate regulation of these yahoos, but we basically work different sides of the street so, while a flash crash will affect me for a couple of days, I can use Wall Street's foolishness and venality to my own advantage. You can try to fight 'em using their tools, you can join them, or you can ignore them. As much as possible, I choose the last course."
Our current portfolios reflect our optimism. But nothing goes straight up or straight down. Every day the market goes up, the more overloaded the boat is becoming on the "greed" side of the fear/greed equation: a gnawing sense on the part of many investors that they are missing something. And they have, of course. January 2012 enjoyed the largest January gain in history for both the Dow and the S&P 500. I believe people need time to digest these gains and that, for many, the temptation to grab whatever profits they can before what they see as the inevitable next slide down, means we will have a pullback.
Unlike many commentators, I see that "slide" as relatively slight and well-contained. Still, we have been placing ever-tighter trailing stops all during February. It doesn't matter that I see this as an excellent year; it matters that we get ahead of the crowd our clients and avoid the falling knives investor panic creates. The catalyst for the decline could be something real, like soaring U.S. unemployment or terrible corporate earnings, or it could be a chimera like Greece defaulting or fear of Europe dragging us all into the morass. (Re the latter: the highest estimate I've ever seen show that Europe represents no more than 10% of the earnings of S&P 500 companies. We are competitors of the big Euro firms rather than suppliers or recipients of their sub-contracting. In addition, I read a great quote from Lazard Capital Markets' head of Product Strategy, Art Hogan, who noted, "Portugal is smaller than Greece. If Italy's economy was a dinner meal, then Greece and Portugal's combined would not be enough to leave the tip."
None of this means that one can simply buy and hold yet! "There is many a slip twixt cup and lip." Though I believe the year will end well, I expect thrills and spills along the way. Those facile fools who say things like, "As goes January, so goes the year," are repeating trite piffle that will doom them to lose even as we exit the year with a profit.
There are no short cuts to investing success. Yet every year people too lazy to do the hard analysis required to beat the market try to take short cuts like the "January Barometer." An up first five days of January means the year will be up? Dumb. The market rises roughly 70% of the time anyway (albeit not in Secular Bear years!) If you just said, "The market will rise every year," you'd be right about 7 out of 10 times (which is why perennial optimists get all the forecasting jobs on Wall Street). So to say, "The market will rise if January — especially the first five days of January — rises," is stating the obvious — but for the wrong reasons.
Since there is a January effect in most years, however, and since the market goes up most years, there is a strong correlation. But is it causative or merely correlative? I'd argue the latter. The fact that the first five days of January are up, or even the whole month of January is up, doesn't mean the market is destined to outperform. The fact that the market is up most years, anyway, simply gives credence to throwing bones in a circle, reading tea leaves, or using astrology or the January Barometer to "predict" an up year. I think tea leaves, old bones, and the January Barometer are harmless distractions unless you take them seriously with serious money.
What you might want to note, instead, in support of an up market this year, is that there is a latent strain of optimism that runs through the American national consciousness. We believe in vast frontiers and the power of high technology, cosmetic surgery, and paying taxes up to the point of fairness to propel us ever forward. For that reason, we simply cannot abide this many down years in a row. American optimism and, more importantly, American entrepreneurialism, spurred by a complete revamping of the idiotic way we invite immigrants to our country, will be a better barometer than the date on the calendar every time.
Putting aside the January Barometer as unworthy of serious consideration as a predictive tool doesn't mean we should ignore the January effect. This is typically due to large asset inflows and/or year-end repositioning of portfolios from institutional investors. Big mutual funds and others hold what they have at year-end, hedging so they can hang on to whatever gains they have and get their bonuses for beating the benchmarks by .00001%. The New Year gives them a reason to get frisky again — after all, they'll have 50 weeks or so to undo any damage they do by taking big risks on small companies early in the year. (And those small companies just might provide good gains to create a cushion for mediocre performance the rest of the year.)
Then there's the self-fulfilling prophecy angle: Once the January effect became well known, investors who didn't want to miss out put cash into the market, thus confirming the hypothesis that the market rises in January. There could even be an element of New Year's resolutions at work, as people resolve to save and invest more this year. And people often do get cost-of-living increases, raises, bonuses and retirement plan contributions at this time of year, all of which mean money that needs to be saved or invested.
I'm not one to look a gift horse in the mouth. If someone wants to give us a 10%-plus gain in six weeks, we'll take it. But we'll now tighten up our trailing stops so we still retain 8-9% if I'm correct and the market takes a breather here. There will always be other opportunities for those of us who don't choose to follow the market up and then right back down. I don't expect a correction to last more than a month or so, but I think it will be less than enjoyable for the group that wants to buy and hold, and I'll wager will only reinforce the stubborn view of those who believe we are doomed to enter a Great Depression. The former will give back a chunk of their profits, the latter will stay on the sidelines until the news is all rosy again. We think there's lots of money to be made between now and then! Place trailing stops on your stocks and see future articles for what we will be buying.