Published: Nov 10, 2015 10:44 a.m. ET
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Before the Monday, Aug. 24, thousand-point down day, I warned readers of my investment letter to be ready for the market to correct, quite possibly via an "elevator drop" and to get ready to buy stocks on our list of attractive companies. Prior to the "mini flash crash" as I've heard it called, I warned here on MarketWatch that "things were getting bearish," and "stocks were not properly priced.“ Smart investors spent the spring and summer raising cash and preparing a list of stocks and ETFs to buy when opportunities arose.
Retail investors are getting it half right, moving money out of stocks for the past year. Most have done so out of fear of the "next collapse," as they did in early 2009 before finally reinvesting around 2012. This time, they are close to their portfolio highs from the middle 2000s and believe they should get out of the stock market before the next crash. That makes some sense, better to pre-panic than post-panic.
Investor fear, primarily among baby boomers, is probably well founded in the short-term. The world is facing serious economic headwinds driven by demographics and debts which I have covered in several columns, investor letters and recently in my monthly investor webinar. The combination of investor skepticism, a slow economy and a Federal Reserve that keeps talking tough makes it very probable that we are going to get another thousand-point down day very soon. In fact, I am pretty sure we will get two or three within the same few weeks.
How horrible will it get for the stock market? How far will emotional sellers and traders drive the markets down? Will it be the beginning of another financial collapse? Here's what I think.
I believe fear and emotional selling will drive the stock market down into official bear-market territory, however, I have a hard time making a case for anything more than a run-of-the-mill bear market. It also seems to me that there is not enough stupid retail money left in the stock market to take it below the strong support level around 1550 on the S&P 500 for more than a week or two. For traders or those seeking a hedge, rolling put option positions on the SPDR S&P 500 SPY, +0.00% makes a lot of sense to me given those contracts are cheap and have potential large upside.
Market structure could have something different to say about the ultimate bottom, of course. This year, the traders have taken most control of the markets away from investors. It really is a remarkable phenomenon as they move from sector to sector, and stock to stock, blowing things up while the biggest stocks barely notice. Could the traders blow the whole thing up? I think for a flash-crash minute they could, but it wouldn't last long. The fastest traders would reverse things on the slower traders, as value hunters sitting on trillions of dollars finally take out their wallets. The rebound rally would be fast and huge.
If the October rally demonstrated anything to us, it is that there is still a lot of money on the sidelines willing to buy the bigger dips. We know that family offices raised cash allocations over the past year, something I covered back in March, and that they will eventually move back into more equities. There are also money managers of many shades, just waiting to buy the quality assets they want to own for the intermediate and long term.
For those worried about a financial collapse who keep yelling "global debt," we are not on the cusp of another financial collapse. There is simply too much available money in the world and more at the ready whenever anything remotely resembling a collapse threatens. Remember, don't fight the Fed? Well, don't fight the Bank of Japan, European Central Bank, People's Bank of China and any number of other central banks either. If they have to monetize (socialize) half of the planet's debt and worry about inflation later, that's what they will do. Mind you, I'm not arguing that's right, I'm just saying it is reality.
Phillip Van Doorn recently published a great chart that showed how the various sectors of the economy did leading into Aug. 24 and since. It's worth a look to see where the strength and weakness could be in the next year or two.
If you are a bit contrarian like me, you will like what is shaping up in energy. TheSPDR Select Energy XLE, +0.51% is pretty far along in its bottoming process touching its five year low twice this year. If it approaches that low again, I think opportunistic wise investors would be smart to overweight that position.
Kirk Spano and certain clients of Bluemound Asset Management own puts on SPY. Kirk has recommended puts on SPY to subscribers of his investment letter Fundamental Trends. Neither Mr. Spano nor Bluemound clients plan any transactions in the next three trading days. Opinions subject to change at any time without notice.
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