What If We're Wrong?

Many investors believe that the most important part of their investment strategy is being right about what will happen next in the market. However, while being right can be an incredible boost to the ego and make you very popular at cocktail parties, as an observer of the markets since 1980, I can say one thing with absolute certainty; nobody is right year in and year out. And as Ned Davis is famous for saying on the topic, “It isn’t about being right, it’s about making money.”

Thus, if you want to be successful in the markets, you’d best figure out a way to deal with failure. I know it’s an overused cliché but as is the case with professional baseball players, failure is just part of the game. So, just as baseball’s best hitters will fail to reach base more than 60% of the time, a money manager knows that he will have positions that are “wrong” each and every day he walks into the office.

So, this weekend I wanted to spend a couple minutes objectively asking the question: “What if we’re wrong?”

The Premise

If you’ve read any of our weekend missives over the past three months, you probably know that we’ve taken a pretty strong stance about what we believe is happening in the market and also about what we expect to see happen over the course of the next 6 months or so. And frankly, I’m fairly confident that many are growing tired of hearing about the idea of a “mini” bull market occurring within the context of the secular bear market that has been going on since 2000.

However, what we haven’t spent a lot of time talking about is the “why” behind our market premise. And as anyone who knows me at all will attest, I’m very big on understanding why things happen the way they do in the stock market.

So let’s review. For starters, we believe strongly that the final leg down in stocks that occurred from early January through March 9th was the market’s way of discounting the potential for financial Armageddon. There was fear that the banks would need to be nationalized and a run on both the banks and money market funds was a single headline away. Thus, traders knocked stocks down to levels not seen in more than a decade in response to the uncertainty of what might come next.

However, everything changed once bankers reminded us that they were making money with the yield curve set up to borrow at 0% and lend at 5% and the mark-to-market rules were modified. Suddenly, Armageddon was off the table and the talk turned to the “green shoots” of recovery.

Thus, the next part of our premise for what has transpired is that the rally from March 10th through early the end of April was the removal of what we’ll call “the Financial Armageddon discount.” One look at the charts makes it very clear that the rally into April simply took the Dow and S&P back to the levels seen during the late-October through December 2008 period.

From there, traders, economists, and analysts alike stopped focusing on the banks and turned their eyes to the economy. And with some signs of improvement beginning to show up in April and May, the idea of the recession ending became the common theme of the day.

The big rally from the March low into early May pushed the indices up enough to trigger a bunch of very long-term and very reliable buy signals. Thus, by May, we were looking at a new bull market of sorts. However, based on the debt levels in the economy (which are still off the charts!) and the likely change in consumer attitudes in the wake of the dive in home values and 401(K)’s turning into 201(K)’s, we felt that this was not 1982 revisited. Thus, we got behind the “mini bull” concept. I.E. a strong rally within a longer-term bear market.

Although there have not been a great many instances in the U.S., there HAVE been periods where mini bull markets existed within the context of a secular bear market. And while we won’t bore you with them all, the best examples include the 1966 – 1982 period in the U.S. and the 1989 – present period in Japan.

The Next Leg Higher?

So, with the “Financial Armageddon discount” fully removed, a new bull market underway, and investors focusing on the economy, our premise then