Weekend Ramblings

I don't want to get caught up in the ST market action too much  but I can't resist making some comments about what transpired this past week. Given the run we've had in the market since November, the bears had every reason to really hammer the market on this  very weak jobs number and all they did was land a jab. There's a pretty good chance Friday marked a ST bottom if you look  at not only how the market clawed back more than half the losses but also if you look at the big spike in bond prices. Pull up a chart of TLT and you will see that ST stock market tops and bottoms (especially the latter) are marked by steep ST drops and spikes in TLT respectively. Friday's spike in TLT was huge and so that suggests either a ST bottom in the market was made Friday or we're very close to one.

Bigger picture wise, making a judgement about the state of the economy based upon a few data points that came in "weaker than expected" is not smart. There are however some things that support the bear case.  There will be a fiscal drag in the coming months as government spending is set to reign in due to "sequestration" which began in March. Perhaps this uncertainty is largely responsible for the weak jobs number in March...could be a just a coincidence though. $85 Billion in government spending will be cut this year alone. That represents about .5% of GDP....not huge but it's notable.  Then there are the tax hikes that took into effect early in the year which I've read could knock off another 1% this year. That's a 1.5% fiscal drag this year which in this slow growth economy is quite large. Bernanke expressed his concerns about the state of fiscal policy in US. Offsetting this fiscal drag is the tail wind of the housing sector in the US whereas unlike in previous years, housing looks poised to contribute to economic growth rather than subtract from it. I've read it could boost GDP 2% and so that makes it a wash when combined with the fiscal drag. There's always the possibility that some sort of deal takes place which improves the fiscal situation in the US but on the flip side, there's also the possibility that the US housing recovery stalls...lot's of unknowns but I don't see the threats as significant longer term at this point.

On the monetary policy side of this things, there is massive accommodation across the globe. Japan has  taken a page out of Bernanke's playbook and announced a very aggressive $1.5 Trillion  monetary stimulus measure by vowing to double its monetary base in 2 years i.e. a major QE operation. Like what Dragghi said last year, Kudora vows to do whatever it takes, and in this case, it's to break the back of deflation which has plagued Japan since the early 90s.  I'm sure this is going to bring about moans and groans from the permabear "intellectuals" who will claim you can't print your way to prosperity, it's a moral hazzard, blah, blah, blah but the fact of the matter is you now have the heads of the 3 major central banks of the world with the petal to the metal with most other central banks also in accommodative mode (but not as extreme). Bear markets simply don't begin with such conditions....they always began when monetary conditions were restrictive.

I've also been pointing out for sometime now that despite the markets having rallied strongly for 4 years, there's still plenty of skeptics without any of giddyness/greed you typically see at a bull market peak. Mind you, I could have (and did) say the same thing in 2011 before the market had a 20% correction...but I'm talking about long term here. John Templeton once said bull markets are born in pessimism, rise on skepticism, mature on optimism and die on euphoria. I think we're late in the skepticism stage with "green shoots" of  optimism. I came across this great chart which actually illustrates the validity of Templeton's market cycle and where we stand now. It uses over 40 inputs to derive a measure of investor "risk appetite".  There's 5 levels of risk appetite in this chart which fit well with Templeton's cycle . 1) Averse (pessimism). 2) Reluctant (skepticism) 3) Neutral (late skepticism/early optimism). 4) Seeking (optimism). 5) Loving (euphoria).

Right now risk appetite is only at neutral unlike the last 2 times the SPX hit 1550 at the bull market peaks of 2000 and 2007 when investors were risk loving. Another major difference between the market now vs 2000 and 2007 is that monetary policy is extremely accommodative whereas it was restrictive in the other 2 periods (rising interest rate environment leading to an inverted yield curve). I've said it before a few times, bull markets die when there is the lethal combination of greed and tight money. We are nowhere close to that right now. Does that mean we can't get nasty corrections some of which can be prolonged and last several months? No! What it does mean is that the correct posture is to be a LT optimist on the markets and position yourself accordingly i.e. looking for long side opportunities and avoiding the short side (aside for hedging).

Riding this bull market has NOT been easy. We've seen some crazy volatility at times including a nasty 15% and 20% correction in 2010 and 2011 respectively and I have had my doubts a few times but in the back of mind no matter how bleak things looked I always knew that prior to these corrections we did not see the classic conditions for a new bear market and so I never gave up on the bull thesis. We could very well see a situation this year again where serious doubts about the bull market come into question due a nasty correction. I personally however, am not going to hedge for a correction unless I'm quite certain one is imminent  Given my LT bullish outlook, I'd prefer to error on the side of being too bullish than too bearish.  Right now I don't see enough evidence  that a big correction is immanent especially since bonds have spiked so much. I have about 20% in cash and so for now that's my defensive position.

There's a few major opportunities I see out there and I'll about them next post.