a shifting market

Happy Halloween!!

In addition to its religious significance–and the general opportunity to gorge on candy–Halloween is important to investors in particular because it marks the end of the fiscal year for most mutual funds. That’s important because funds typically do their yearly tax and distribution planning (both involving net selling) during the six or eight weeks running up to today. That’s usually followed by a rebound that lasts for a month or so.

This year the S&P 500 peaked in mid-August and fell pretty continually until two weeks ago. The depth of the decline–a loss of 17%–and the length of the selling period–two months–both suggest that while seasonal selling might have been a factor in the losses, it’s not the whole story.

If so, it’s not clear whether we’ll see the typical rally into yearend.

My sense is that we may also be seeing the start of an important shift in investor sentiment away from large-scale macro factors–interest rates, the peaking of government pandemic relief spending, the healing of supply chains–to more company- and industry-specific factors. We can already see this, I think, in the widely differing market response to disappointing earnings being reported in the September-quarter reporting period. Results from the autos, for example, are being shrugged off, while those from, say, META or AMZN are triggering substantial selling. With the possible exception of META, my sense is that the market is trying to assess the extent of companies’ excess inventories and the skill/lack of that they are displaying as they attempt to minimize their negative effect on future results.

Oddly, and maybe because it’s happening and I’m not seeing it, the strength of the dollar–meaning the weakness of foreign currency-denominated results–hasn’t made much difference to Wall Street. It’s more an evaluation of good management vs. not so much. Still, this seems to me to be a more sophisticated approach to stock selection than we’ve seen over the past couple of years.

capitulation? (ii)

on yesterday’s post

When I think of capitulation, I think of a climactic event. A selling panic–a short, sharp, highly emotional, fear- and margin call-induced, high-volume market decline. It signals the final purging of any speculative belief that may remain from the prior bull market. It also establishes a base on which the gradual return of positive sentiment can build. October 1987 or March 2009 are prime examples of this.

The ultimate significance of epic selloffs like these is only 100% clear once time has passed, the big question being whether there’ll be an aftershock (there usually is) and, if so, when and how bad it will be (often six weeks or so later and less shocking). Still, they are pretty clear markers that a bottom is forming.

Sometimes, like now, we’re not “lucky” enough to have a few definitive ugly days from which to argue that the worst is over. So we have to depend on less reliable secondary signs: valuation of securities and institutional investor positioning (the latter meaning a judgment that these investors have done all the selling they’re likely to do).

So the assertion in the Merrill report I wrote about yesterday that we’ve entered a post-capitulation market may have been calculated more to get press coverage than anything else. The real question is whether we’re at the worst now and this bear ends with a whimper.

what I’m thinking/doing

–I’m in the out-with-a-whimper camp. I’d be feeling more bullish if part of me were trying to figure out how I’d make a living selling NFTs of apples on street corners, but the reality is that I’m not at that extreme of worry

–if we characterize the market of 2020-21 as one where stories and concepts counted the most, I think the keys to success in today’s market are valuations and near-term earnings/earnings growth

–one of the oddities of the current market is that some former concept stocks have been pummeled enough that, while they may not have stellar earnings at the moment, they are, I think, trading at discounts to asset value. There are big conceptual issues for investors to deal with in this area, including: integrity of the financial statements, assessing the value of tax losses and calculating the worth of intangibles like brand names and proprietary software. I own HOOD. But although I find the area interesting and I think takeovers have the potential to buoy investor sentiment, I feel there are easier ways to make money right now, like…

–figuring out how the post-pandemic world will work. Specifically,

—identifying (and avoiding) pure stay-at-home companies vs. companies that will benefit from the return to whatever the new normal will turn out to be

—I think it’s roughly correct that at mid-year retailers had 50% more inventory than usual. The consensus view, I think, is that supply chains will be back to normal within six months, meaning all that extra should be gone by then. Probably good for the TJXs of the world. TGT says it has already handled its excess. Who will be the losers?

—working out the implications of new restrictions for tech hardware companies on technology transfer to China

—the oil/base metal/electric car nexus, including the speed of change and what shortage items may be


The Merrill Lynch subsidiary of Bank of America has produced a monthly survey of portfolio manager positioning and sentiment for many years. My attitude when I was working was that I would like to see the results but I wasn’t too keen to yield any competitive advantage I might have by taking part. On the other hand, to a knowledgeable reader my portfolio spoke for itself.

According to a Reuters article, the latest of these, with data reportedly at most two weeks old, “screams capitulation,” as Merrill strategist Michael Harnett put it in the survey report. I’ve only seen reporting, not the survey itself, so I’ve got to be aware that I’m seeing data that has already been filtered. Still, a few things jump out to me:

–cash levels are the highest in over 20 years–lower than in the aftermath of the dotcom crash in 2000, but more than during the banking/world trade collapse of 2007-08. That’s really saying something, but whether about the world or manager risk preferences isn’t clear

–multi asset funds are overweight cash and underweight equities. For managers in general, equity industry positioning is defensive, with Utilities and Staples the largest overweights

–PMs think we haven’t reached the ultimate market bottom yet.

My thoughts:

–I read the report as saying there’s no percentage in becoming more bearish, since it seems everyone understands the world economy is currently in bad shape and, more importantly, has already (long ago, most likely) acted on this

–a corollary: there’s no percentage any longer in having an overweight in Utilities or Staples. A non sequitur–same for Oil, I think, mostly because the price is going sideways at a time, both seasonally and because of OPEC cutbacks, it should be rising. Base metals may be a better place to be, but this is a real specialist area. Is it worth the time?

–if the lows are 10% below where we are now, and they are followed by a 10% rally, then the index ends up being lower than we are now after both happen. If on the other hand, we’re 5% above the lows and the following rally is +15%, then there’s no sense is remaining in a bearish posture

My guess is the second is more likely than the first, but this is not something I’m going to bet the farm on

tomorrow: where I think we should be looking

a non-consensus thought

The market I’ve had past experience in that, to my mind, most resembles the US during the pandemic era is Japan in the late 1980s. The essence of both places/periods, as I see them, was wildly speculative behavior spawned by, and taken to considerable excess as a result of, near-zero domestic interest rates.

There were three key elements to success in the Japanese market in the 1990s, as it struggled to recover:

–avoid the companies, many of them real estate-related, whose main attraction was either a “story” not backed up by earnings and earnings growth, or extreme sensitivity to interest rates

–avoid companies with hidden losses, created by managements’ imprudent stock, bond and/or real estate market speculation and covered up by refusal to mark to market. This was a decade-long public company issue in Japan, but my guess is that it’s more likely a hedge fund/private equity problem in today’s US

–recognize the continuing power of the backward-facing traditional industry conglomerates, to shape local politics to their benefit, as China-based competitors began to take market share away from them. This implied a negative overall view on Japan’s GDP growth prospects, and therefore looking more for smaller “maverick” companies, like Uniqlo, rather than the largest and highest profile, zaibatsu-linked, names

For the US today, it seems to me the first is a given and the second is more likely a private equity/hedge fund/endowment issue than a public market one. The third suggests that traditional US growth stocks (i.e., better than expected earnings growth, for longer than expected) will do fine. Many of the zaibatsu-equivalents in the US are privately held, so they’re not an issue for stock market investors. Although traditional value stocks are not really my thing, I suspect that the contemporary relevance of the assets they hold will be a more important issue than has typically been the case.

Maybe summing this all up in one sentence, the boat we’re in will likely be much more crucial than the state of the tide.