Biding my time

Markets have been hit primarily because of  Emerging Market jitters as the currencies of some of the smaller countries like Turkey and Argentina have taken a big dive. This is apparently the result of QE tapering fears and China showing a continued slowdown. You can pretty much pick any excuse; when the market is frothy from a sentiment perspective as I described in my previous post, it becomes much more vulnerable to negative news.

If we continue to see negative consequences to the unwinding of QE, whether it's actually responsible for it or not, then it's likely going to be the case that the upside of the market will be capped until QE tappering has ended or is close to ending and the market senses that there is no serious fallout from it. This means that we could see a choppy or down market for the majority of the year much like 1994 and 2004, which were also years where the Fed was taking away monetary stimulus. Mind you, in 1994 and 2004 there was outright tightening via rate hikes whereas this time around it's only unwinding of QE and monetary conditions would still be very accommodating without QE. However, there's this wide held belief that the market is dependent on QE and I'm sure you've see the charts which show the correlation of the market's performance with every round of QE.  This effect could be more psychological than anything much like how a child feels brave if he has his favorite blanky and so if you deprive this child from his blanky he will be afraid and has to go cold turkey for a while before he realizes that there was nothing to be afraid of all along. By no means do I claim to know the actual impact of QE or lack thereof but I suspect that it's not as critical as many are suggesting. One thing I'm quite sure of is that QE is no magic bullet and that any positive economic response it may have achieved was because it was initiated at the right time, i.e. it was initiated at a time where the economy had largely purged itself from the excesses of the prior cycle and pessimism was thick; therefore the economy had a lot of pent up upside potential making it more likely to react effectively to stimulus. If for example QE was initiated in early 2008 when the economy was only just beginning to rollover I doubt very much it would have prevented a major bear market. Anyhow, that's my worthless 2 cents on the subject. Debating these kind of things can be interesting but then you start getting into the realm of dogma and the more dogmatic your beliefs are, the less investable they are. 

The bottom line for me is that I want to see the froth taken out of this market before I get can comfortable committing more to it and when this happens it will show up in the same indicators that warned me about the froth. As I said in a recent post, I got the distinct feeling that there are too many weak longs in the market who are only long because of momentum. Now we are probably starting to see these longs bail. I don't know how long this process will take and I'm sure there's going to be sharp bounces in the interim and perhaps we're gonna get one of those soon,  but I'm just going to bide my time keeping my bat on my shoulder for the most part while waiting for the medium term risk-reward situation to significantly improve. If I see something really, really enticing I should probably go for it - at least partially, and perhaps put on a hedge. I don't want to be a hostage to the broad market but I'm well aware of the rising tide lifting all boats phenomenon and how this applies to the downside as well.