Monday, July 19, 2010

Can we still apply the buy-and-hold strategy?

We thought that maybe we should take a step back and just see how well (or badly) certain indexes and ETFs have performed during the last 5 years. Below is what we came up with, or shall we say, it’s what the market came up with.

It is clear that the notion of buying and holding equities for the long-term is no longer applicable in this market, especially recently.  It is also clear that gold is ... well, its golden!  Here is some additional data: S&P500 is down nearly 30% during the last 10 years, while the volatility index (VIX) is up nearly 36%. These are the figures that casinos love to see - people gambling more (increase in VIX) and losing more (decline in S&P500).

We believe that the performance of stocks no longer necessarily represent the performance and/or health of a company or the economy. One may ask whether the stock is the chicken and the company is the egg, or the other way around. But merely the existence of such a dilemma or question is telling us that the performance of a company (in terms of growth, profitability, etc.) may now represent less than 50% of the performance and valuation of that company's stock. Simply put, fundamental analysis is now out the door, at least for the time being. Diversifying away stock specific risks is no longer applicable. Stock specific risks are now nearly impossible to identify, as again, we no longer place much emphasis on a company's or the overall economy's performance. And the systemic risk, we think the government has failed to minimize.

One may provide a rebuttal and propose that given such 'transition' in the market, investors must begin to adjust the way they value stocks and lower weight given to fundamental analysis of companies. We agree, if the objective is only to beat the market.  We agree, if the objective is to gamble just like one would when visiting Palms, Wynn, Caesar's and many other casinos in Las Vegas (or Macau). Well, as mentioned earlier, at least some figures demonstrate that the market is becoming a casino. But all of this will make the economy dependent on the stock market.  Excuse us, we just realized that this is already the case.  The economy is dependent on the stock market. The stock market is no longer an indicator of the economy.  The health of the economy is based on how high or how low those stocks go. Is this really the type of economy and equity market that we'd like to have? In our opinion, no.

There are many reasons as to why the market is becoming a casino (if it hasn't already). The one that stands out is the huge influence that large businesses and/or industries have over the government. The leverage that these lobbying groups have over our so-called lawmakers is unbelievable and it could surpass leverages historically demonstrated by the NRA, AIPAC, etc. And we're certainly not blaming the lobbying groups as they have a right to push for what's best for them and their clients.  The lawmakers and their 24/7 election concerns are what concern us.  From the day they get elected, they begin to think about their re-election campaign strategies, which certainly makes them more and more vulnerable to that cash and those promises and possibly threats they receive from lobbying groups. 

Basically, nearly every industry gets its way. All of this creates more red tape for other industries and this goes round and round, and creates a potentially very costly cycle. The red tapes create additional risks for the market. The red tapes induce many (mostly the quants on Wall Street) to design securities to get around them or to make money via them. By the way, we believe they have a right to do so.  This again adds to volatility.

The market will likely become more volatile, as we have seen (and as indicated in the table shown earlier). Volatility may be good for professional traders/investors and quants, but it is the worst for retail and Mom & Pap investors. And they are the people that drive this economy. They are the ones that consume, of which we have not yet seen enough. 

Besides our whining and complaining we think the market could take a further dive.  From a technical standpoint, if S&P500 goes below 1050, then 1000, or another 6% decline, could be next.  In addition, although the 100-day and 200-day moving average (MA) have not yet begun to trend down, another couple of flat to slightly down weeks could initiate the downward trend for those MAs, which would also make it more likely for them to cross. 

We note that as compared to 3 weeks and 5 weeks ago, when S&P500 was basically at current levels, VIX was between 9% and 33% higher than where it closed at on Friday.  This may somewhat lessen the fear in the market.  However, we believe this is mainly due to expectations of good earnings releases during the next few weeks.  Unfortunately, we also think that the good numbers will likely be followed by disappointing guidances.  Its during most earnings seasons that the market and investors realize that fundamental analysis of companies just cannot be ignored. 

Lastly, given the lack of artificial high provided by the government for the real estate market, the market appears to be dispplaying withdrawal symptoms, similar to many drug addicts.  We think basically the housing market, the auto market and the rest of the economy has become addicted to government help.  Once aid from the government is no longer available, the markets get off of their artificial highs.  We're seeing this with the real estate market.  Next week's building permits, housing starts and existing home sales figures will likely be disappointing, even with the more conservative estimates.  In addition, we think initial jobless claims will increase as last week's reported decline may have been due to the shortened 4th of July week.

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