Leveraging Fear.

October 10, 2014

Halloween has arrived at an appropriate time. Because Americans are terrified.
Ebola. ISIS. Border security. Weird respiratory conditions in our grade schools. Plummeting stocks. The end of stimulus. Recessionary symptoms within our biggest trading partners. An odd midterm election more reminiscent of a Seinfeld episode, than a contest of ideas. And a president that has not engendered much confidence, of late.
Once again, peachy has been relegated to a flavor of ice cream.

As the S&P 500 tests its 200-day moving average for the first time in three years, investors are understandably anxious. Which is why I'm not.
Don't get me wrong. Stocks could fall further. In fact, they likely will. Because fear, like most contagions, burns fast and hot before extinguishing itself. Fear sends investments lower. Leaving better upside for those willing to face it, stare it down, and use it to their advantage.
But first, investors must ask themselves, what is there to fear? Why, given that stocks just hit new all-time highs less than one month ago, are things so ugly? What has changed?
True, Europe and Asia are clearly not in step with the America economically. And yes, QE3 concludes this month. And of course, markets -- like trees -- do not grow to the sky. So must this six-year bull market end at some point. But not now. Not likely. Not without having achieved some semblance of exuberance. If not, at least, passive indifference.
This current tremor? Vanilla. Run of the mill. Historically insignificant.
Bull markets thrive on shaking out those lacking conviction. By employing rapidly rising levels of fear and volatility. Which is why the stock market typically provides returns above bond yields. By employing that dreaded, fear-inspiring volatility.
Like a man standing alone. At night. Wearing a dark, full-body Carhartt jumpsuit. And a hockey mask. In your yard. That man? That's volatility.
With investors still clinging to fears from 2008's credit crisis, each jump in the VIX volatility index feels as if the bogey man has reemerged. And a fresh-faced Jamie Lee Curtis remains, unknowingly, in harm's way.
Only, what has changed? The forces that recently pushed the S&P 500 to new all-time highs remain intact.
Leading us to conclude that this is no horror show. Most current fears are misplaced and overblown. So presenting an opportunity for those still underweight equities. Here's why.
Global weakness emanating from Europe and Asia will likely keep interest rates low for some time. That, as the U.S. economy expands and corporate earnings continue growing. Both of which will combine to push equities higher these next twelve months.
"But, Europe and China are slowing. Surely the U.S. economy must not be far behind, right?"
After a scary weather-related drop in Q1 GDP, Q2 saw economic growth hit 4.2 percent. Economies do not topple into recession when GDP growth is accelerating. American economic momentum is trending higher.
Moreover, U.S. balance sheets are improving.
Regardless of what passes for fiscal propriety on The Real Housewives of New Jersey, real American households have seen an improvement in debt-to-savings ratios. As have corporations. And lower ten-year interest rates will push mortgage rates lower, which should stimulate home building. As well as corporate profits as debt payments decline.
Further, given the piddling yields currently proffered by bonds, where else will global investors allocate capital? Remember, so long as the risk-premium on equities remain above the ten-year treasury yield, equities will attract capital. And with European and Asian economies weakening, U.S. stocks have only grown more attractive.
Institutional investors constantly assess whether to own more stocks or more bonds. Their decision making is driven by what they can earn in safer fixed-income investments. When corporate bonds offer high annual yields (8%-10%), institutional investors sell stocks and buy bonds. Enabling them to "lock in" gains and earn relatively high "risk-adjusted" returns on capital.
Which is another reason we don't anticipate a significant bear market in stocks. At least not until corporate bonds fall in price. Remember, bond prices move inversely to their yields. So a drop in bond prices would send yields higher. So driving investors to shift capital from stocks to bonds.
Of course, some argue that stocks will not fare well when rates eventually rise. But, given the economic circumstances of our trading partners, why would the Fed abandon its zero-interest-rate policy anytime soon? And using history as a guide, we find that stocks usually rise going into the first interest-rate hike. Then, following a small correction -- usually around seven percent -- they keep moving higher.
Another good omen would be a positive Christmas shopping season. Perhaps we could put a few extra bucks into the pockets of consumers... voila! As the price of crude oil descends towards $85 per barrel, the average American will find himself with a bit more discretionary income. Just in time for the holidays.
Look, we can't blame the American public for behaving like a bunch of fourth-grade boys in a haunted house. The media laps up fear and volatility like my Border Collie does meatloaf. How else will they keep your undivided attention until the next spate of mundane product advertisements? Today's news anchors use hyperbole like Billy Idol does hairspray. And like Pavlov's dog, the public responds. Selling stocks. Seeking shelter. And quivering like Liberace's Chihuahuas.
Get a hold of yourselves, people. Despite government ineptitude at the highest ranks and whatever passes for leadership these days, this market wants to rise. Nor is there anything capable of stopping it so long as inflation remains in check, interest rates remain low, and equities remain the only game in town.
When lacking good answers, we need look no further than recent history. For he is a thoughtful counselor.
In 2011, stocks raced higher in the first and second quarters. Then, halted abruptly when the major ratings agencies downgraded the U.S. credit rating. From mid-April through September, the market plummeted roughly 20 percent. Investors howled. Bailed like rats. Only to watch the market turn on a dime and rise sharply higher for three years.
Which brings us to today. The S&P 500 sits nine percent below the high achieved one month ago. Stocks look like falling cutlery. Not to be grabbed.
And yet.
Stocks and real estate will push higher between now and the first interest rate hike. Late 2015? Early 2016?Stocks will then pull back. Before heading higher. That's what history tells us. Who are we to argue?
Historical evidence remains on our side. Our playbook? Set long ago. Encompassing strategies for grabbing everything the market might provide on its way up. And for exiting quietly when the herd begins to panic.
Yet, there is scant justification for today's level of fear emanating throughout global markets. But remember, fear is a liar. He is not real. Simply the stories we tell ourselves. Products of our imagination.
Danger? Danger is real. Fear, on the other hand, is a choice.
Thinking about your fears will not help. But action will. Action cuts right through fear.
So, what's your action plan? Do you know your next three moves if the market recovers quickly? Continues falling? Drops precipitously? An action plan doesn't have to be brilliant. Just historically cognizant.
For as Charlie Munger astutely said, "You don't have to be brilliant, only a little bit wiser than the other guys, on average, for a long, long time."

Securities offered through Dempsey Lord Smith LLC – Dempsey Lord Smith LLC, Rome, GA Member FINRA / SIPC / MSRB.

Advisory Services offered through Dempsey Lord Smith, LLC, an SEC Registered Investment Advisor. Clearing through and accounts held at Charles Schwab & Co., Inc.

Dempsey Lord Smith, LLC nor Hyde Park Wealth Advisors LLC provides tax or legal advice and you should consult your accountant and/or attorney if considering an investment of this type. Hyde Park Wealth Advisors LLC is not controlled by or a subsidiary of Dempsey Lord Smith LLC. Investing in Alternative Investments come with a variety of risks that could result in a complete loss of principal investment.

Alternative Investments offered as private placement securities are offered only to qualified accredited investors via confidential private placement memorandum. Income and returns are not guaranteed and there are no assurances investments will meet their stated objectives.

© 2024 Hyde Park Wealth Advisors. All Rights Reserved