Thursday, November 17, 2011

"Finding your entrepreneurial spirit and making it strong is more important than the idea or business you are developing." --Robert Kiyosaki

WHEN EVERYONE WANTS TO REDUCE RISK, INCREASE IT (November 17, 2011): The wild fluctuations in the global financial markets since late July have encouraged many investors to sell stocks and other risk assets because they cannot emotionally tolerate the roller-coaster ride. Obviously, buying or selling for emotional considerations is the worst reason to act. In financial publications, you read one story after another about how a financial advisor is telling his clients to reduce risk until they feel comfortable with their holdings, or to diversify into bonds for safety and income, or to select shares with lower beta to smooth out the investing experience.

Therefore, it is almost surely correct to do the exact opposite: to increase your equity exposure; to select those industry sectors with the highest betas; to stay as far away as possible from the most popular fixed-income safe havens including U.S. Treasuries. TLT, a fund of U.S. Treasuries averaging 28 years to maturity, soared to an all-time high on October 4, 2011 and has barely retreated; the U.S. dollar index is not far below its highest levels of 2011. VIX, a classic measure of investors' fear of an upcoming bear market, has pivoted around 30 instead of its usual base of 20, and currently stands in the mid-30s. while we can experience additional short-term weakness in the stock market, a prolonged downtrend cannot begin with investors already so fearful of a repeat of the last bear market and nearly unanimously convinced that we won't experience a meaningful bull market in the near future. Everyone is worried about what Greek or Italian or French bond yields will do, or what disasters lie ahead for China, or anything else that sounds frightening, while ignoring clearly positive trends in the U.S. economy.

Therefore, the most likely course of events would be for general equity indices to retest and probably surpass their recovery peaks. QQQ, a fund of the top 100 Nasdaq companies by market capitalization, will almost surely stage an upside breakout later this autumn or during the winter. The S&P 500 index will likely move above its May 2, 2010 peak of 1370.58. VIX will slide back into the mid-teens. Investors who flooded into safe-haven assets, especially U.S. Treasuries, will just as rapidly withdraw money from them in order to not to miss out on the stock-market rebound. While the mood in the financial markets seems impossibly gloomy for any of these events to occur, just four months ago they all would have been considered highly probable. Reality has barely budged since then; what has changed is the psychology which can just as easily reverse a second time. A bear market can't happen when investors become so frightened after each one- or two-day equity retreat. Be bold, and be bullish.