Sunday, July 15, 2012

"I wish that dear Karl could have spent more time acquiring capital instead of merely writing about it." --Jenny Marx

INVESTORS ARE CONFUSED ABOUT HISTORIC HIGHS AND LOWS (July 15, 2012): In the early months of 2011, many investors were bearish on U.S. Treasuries. The main reason: the observation that Treasury prices were close to their highest prices (and lowest yields) in history, while they were very far from their cheapest valuations set way back in August 1981. Therefore, the reasoning went, it's too risky to buy Treasuries because they can lose a lot of money but they can't gain much. As it turned out, U.S. Treasuries were the top-performing investment for the remainder of 2011 and continued to set new all-time highs in 2012.

What most investors overlooked is that if any asset reaches a new all-time peak, it doesn't encourage most holders to sell. In fact, the exact opposite usually happens: the media become excited about how much higher it can go, and pretty soon brokerages are competing with each other to set more aggressive price targets than their competitors. Investors begin to believe that they can't possibly lose money in the asset, and are even more eager to own it. Whether this is logical or not is another issue: the important point is that buying something which is near an important multi-year or all-time zenith is often an excellent decision because when it does surpass a much-anticipated benchmark, it is likely to encountered by much more buying than selling.

The same situation is true today, except that the asset with a high degree of bearishness is U.S. equity indices including the S&P 500 index. The S&P 500 stands only 4.6% below its multi-year high of 1422.38 reached on April 2, 2012. On the other hand, the S&P 500 at 1356.78 has more than doubled from its March 6, 2009 intraday nadir of 666.79. Therefore, many investors have concluded that it is too dangerous to buy stocks. However, this simply means that it is highly likely that, even without any positive economic news, the S&P 500 will reach a new multi-year top for completely random reasons. When this happens, especially since the widely-advertised Dow Jones Industrial Average will probably achieve its highest reading since 2007, it will create a lot of positive media buzz about owning stocks, and why you should be in the market, and other bullish coverage. This by itself will enable most U.S. equity indices to climb considerably higher.

It's possible that the S&P 500 will have difficulty staying above 1500 for any extended period of time, and it may not even reach that level. However, since so many people are avoiding the stock market out of fear of its unpredictability, or because investors are so enamored with bond funds and are making record inflows into Treasuries and related assets, or because stocks appear to have more potential downside than potential upside, now is probably an ideal time to be accumulating equities. I strongly favor the shares of commodity producers, because they have become far more oversold and undervalued than general equity indices. Therefore, during any rebound attempt, they will likely surge twice or thrice as much as general equity funds in percentage terms.

Disclosure: I am currently long GDXJ, VFWPX, KOL, XME, EWZ, RERGX, SLX, REMX, RSX, TNRPX, VGPMX, TRIEX, FCG, GDX, and NLR, in that order, with by far my greatest concentration in GDXJ.