This blog post originally appeared on RealMoney Silver on April 30 at 9:06 a.m. EDT.
Beginning in early March, the world's equity markets have experienced a classical second derivative rally as the rate of change in the decline in economic activity has decelerated.
Since then, the rally has been breathtaking in duration and scope. And this week, particularly yesterday and this morning, the ramp seems to be accelerating in almost a furious fashion.
Back two months ago, only a few recognized the opportunity that the market's overshoot to the downside presented nor did many see the second derivative economic improvement (in the developing signs of a lowered rate of decline in the change in economic activity).
Some more vocal bears such as Nouriel "Dr. Doom" Roubini called for more capital market pain and a "zombie decade," resembling Japan (a tip of the to Jim Cramer on last night's "Mad Money" show for reminding me of the phrase). The majority of market participants also assumed that the massive fiscal and monetary stimulation would fall on deaf economic ears. A large group of observers even talked depression.
That was then, and this is now. With the
at an 890 level, Mr. Market has now materially distanced himself from both the 666 level and from the notion of an economic apocalypse.
On a valuation basis, equities are no longer on sale. On a fundamental basis, we have not distanced ourselves and perhaps are too readily dismissing the substantive
that will frame the lumpy and inconsistent economic recovery I envision in 2009-11.
The last point merits emphasis, as the presence of unconventional headwinds poses many risks, and since investors have limited experience and historical perspective in dealing with them, it likely ensures a more volatile market backdrop and places limitations to the market's upside potential.
Some of those nontraditional headwinds include the following:
- the broad geographic reach of the current recession;
- the increased burden and cost of regulation;
- the economic impact of the obliterated (but previously important) shadow banking system and the associated reduction in securitized lending market capacity;
- the more important role of government in the private sector;
- the possible impact of protectionism and trade barriers;
- the degree to which individual and institutional investors have become risk-averse and have been "turned off" to equities; and
- most important, the unusual causes of the current economic downturn and uncertainty of business confidence that follows from the deleveraging of debt on bank and consumer balance sheets.
that the same investors/traders that panicked in January to early March are now panicking in the opposite direction in a market that too often worships at the altar of price momentum and that the aforementioned challenges to economic recovery are being ignored.
As seen below, the S&P advance has now eclipsed what was a very optimistic and variant forecast that I presented only two months ago.
I prefer to keep emotion out of my investment equation and to be disciplined in buying what I view as undervaluation and in selling what I view as overvaluation.
From my perch, investors' and the media's increasing market enthusiasm (and even downright breathlessness) could be dangerous to one's financial health in the very near term. And a spread of too much optimism is something that could serve to derail the stock market advance.
For the above reasons (and others), I have been recently expanding my short book into the impressive strength, and I have been liquidating extended stocks in the industrial, cyclical and financial groups as well as reducing my exposure to credit, which has had a nice run to the upside. The areas on the short side that I am emphasizing include selected retail and credit card issuers (as the consumer is still in a fragile state), certain financials such as title insurers (higher interest rates pose a threat to refinancings and home turnover) as well as selected technology (in light of a muted capital expenditure cycle). Importantly, shares in these sectors and many of the individual stocks that comprise the groups are all up significantly in price.
I fully recognize that markets often overshoot. The first week in March was an excellent example of an overshoot to the downside. It seems, too, that the last week in April might be another example of an overshoot -- but to the upside.
Buy low and sell high.
Doug Kass is the author of The Edge, a blog on
that features real-time shorting opportunities on the market.
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Investing A-to-Z section.
At the time of publication, Kass and/or his funds had no positions in the stocks mentoned, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Long/Short LP.