The Wall Of Worry

"Worrying often gives a small thing a big shadow." - Swedish proverb

Since my last blog I have had the pleasure to do some back and forth emailing with a few money managers and some of my investors over my market stance.  Essentially the arguments were that I am either for the market or against the market and at this stage I am paralyzed by a wall of worry and unable to share in the market's current prosperity.  People who cannot stay in the market during the bad times are not rewarded when the market runs and miss out on the upside thereby capping any benefit.  Furthermore market timing does not work and a buy and hold strategy based on a diversified portfolio is the best option.

Certainly a lot to talk about and all good points so let's get started.  On the first point of the wall of worry I am not concerned.  There is a lot of worry out there right now; worry about Greece, the Euro imploding, worry about the massive and increasing levels of debt and worry about the unemployment level and potential inflation rates.  A lot to worry about however while I agree that there is a lot to be concerned about, there always is a lot to be concerned about so what makes this any different?  My answer is that with the large and ever increasing levels of debt that there is a crowding out effect which will slow GDP growth for the foreseeable future.  This will result in lower company profits and will result in a lower market.  Also we have seen what happens when the government puts its foot into the equation in 2000 and again in 2007.  The NASDAQ bubble and the housing bubble (in my view) were both caused by excessive government intervention.  This time around to "fix" the problem the same practitioners that gave us 2000 and 2007 are now printing quantities of money that were only dreamed about years ago.  If this does not work (and I believe that the odds are skewed against a success) then we will really be in trouble so going into the market right now is not the best option.

On the buy and hold and diversified portfolio argument I would say that investing in the stock market should be part of MOST people's portfolio but does not have to be looked upon as a necessity.  If you rewind the clock 20 years the S&P500 stood at 442 and now stands at roughly 1,350.  This is a 908 point move and is up over 200 percent.  Impressive number to be sure, but when you factor in that this occurred over 20 years the compound annual rate of return is around 5.5% per year.  Not so good!  Now when you consider that this does not take into account the massive market swings and assumes that you invested in 1992 and held until today factoring in the market volatility as risk and the risk adjusted return is minimal and no better than bonds.  Furthermore, when you look and see that the market accelerated to 1,530 by November 2000 and still has to recover to that level but has dipped down to 667 in March 2008 the chance of you holding right through that without taking something off the table is a long shot.  If you had to sell at the bottom in 2003 like many people did your return for the period would be less than 3% per year.

My view is to try to seek places where the odds are in your favor and invest accordingly.  As such with the market closing on all time highs, GDP growth up less than 65% during the same period and a poor outlook, it is time to look elsewhere for returns.  I traded the market very successfully in 2009 after the meltdown, struggled in 2010 and looking forward saw more of the same so I decided it better to exit.  Looking back it was one of the best decisions that I have ever made.  In the interim property prices have collapsed and I believe that if you want to start to invest anywhere that you should look at this as an opportunity rather than blindly placing money into a stock investment that really has not produced the returns promised.

In addition I do not think that the majority of people's stock portfolio keeps up with the index return.  Remember that not only does the index re balance regularly at which time the shoddy companies are jettisoned for better companies thereby creating upside bias to the returns, but with the cost of trading and investing mixed into this virtually every investor will not keep up with the market.  This typically knocks off more than 1% a year off returns meaning that stocks have performed poorly for an extended period.  In hindsight it would have been far better to pay off your credit cards or the mortgage on your house which provides a guaranteed return far higher than that of the market rather than taking the extra cash and blindly plowing it into the market.

But what if you have paid off your credit cards and have a decent positive net worth?  My view is that you should sit down with your portfolio manager and review your portfolio on a true risk adjusted basis to ensure that the returns expected meet your desired risk.  I would be surprised if you do not adjust your portfolio after this review.  In addition I would look to alternative investments rather than just the stock market for return.  For those of you trading and speculating I wish you luck and keep the downside protected.  As for me?  I am born to trade so I will be back but for now I plan to sit on my fingers rather than watch them get burned in the fire.