5 Things To Ponder: Words Of Caution

Tyler Durden's picture

Submitted by Lance Roberts of STA Wealth Management,

The financial markets have not done much since the beginning of the year but that is not necessarily bad news.  Despite Russia's annexation of Crimea which sparked threats of military conflict, the Federal Reserve tapering asset purchases, massive "polar vortexes" and less than impressive economic data - the markets have remained mostly resilient. I discussed yesterday that there are signs of deterioration in the market internals which are typical of market tops. 

Howard Marks once wrote that being a "contrarian" is a lonely profession. However, as investors, it is the downside that is far more damaging to our financial health than potentially missing out on a short term opportunity.  Opportunities come and go, but replacing lost capital is a difficult and time consuming proposition.  So, the question that we will "ponder" this weekend is whether the current consolidation is another in a long series of "buy the dip" opportunities, or does "something wicked this way come?"  Here are some "words of caution" worth considering in trying to answer that question.

1) Born Bulls by Seth Klarman via Zero Hedge

In the world of investing there are only a handful of portfolio managers that are really worth listening to.  Ray Dalio, Howard Marks and Seth Klarman rank at the top of my "read every word" they say list.  In this regard, I suggest that you take some time this weekend to read Seth's year-end 2013 investor letter which details the many dangers that lay ahead.  The problem is that most investors are blind to those dangers as they continue to follow the madness of crowds.  

"In the face of mixed economic data and at a critical inflection point in Federal Reserve policy, the stock market, heading into 2014, resembles a Rorschach test. What investors see in the inkblots says considerably more about them than it does about the market.


If you were born bullish, if you’ve never met a market you didn’t like, if you have a consistently short memory, then stocks probably look attractive, even compelling. Price-earnings ratios, while elevated, are not in the stratosphere. Deficits are shrinking at the federal and state levels. The consumer balance sheet is on the mend. U.S. housing is recovering, and in some markets, prices have surpassed the prior peak. The nation is on the road to energy independence. With bonds yielding so little, equities appear to be the only game in town.

But if you have the worry gene, if you’re more focused on downside than upside, if you’re more interested in return of capital than return on capital, if you have any sense of market history, then there’s more than enough to be concerned about.


A skeptic would have to be blind not to see bubbles inflating in junk bond issuance, credit quality, and yields, not to mention the nosebleed stock market valuations of fashionable companies like Netflix and Tesla. The overall picture is one of growing risk and inadequate potential return almost everywhere one looks.

There is a growing gap between the financial markets and the real economy."

2) What A Mean Reversion Would Mean To The Market by Shawn Tully, CNNMoney

I have often written about the consequences of mean reversions, read "30% Up Years", to the average investor.  However, during ripping bull markets, as Seth states above, there are few individuals that have the "worry gene."  I do.  Therefore, I agree with Shawn analysis of the markets and the framework for an eventual reversion.

"Seldom have so many of the metrics that influence stock prices strayed so far from the long-term trends we've come to consider 'normal.' Corporate earnings are far above what's normal historically, interest rates are way below normal because of Fed intervention, and bond prices that wax when rates wane are hovering at seemingly unnatural heights. The typical investor might echo something Yogi Berra could have said: 'I'm confused by the 'new normal' because it's so unusual.'


The total expected return is that 4% plus inflation of around 2%, or a total of 6%. That return comes in two parts. The first is the dividend yield of around 1.6% a year (large companies today pay out about 40% of their profits), and the second is earnings-per-share growth of 4.4% annually. Keep in mind that earnings per share increase at a far slower rate than overall corporate earnings that over long periods track GDP, because companies typically issue large numbers of shares each year, in excess of buybacks, to fund their plans for expansion.


That's hardly a wonderful outlook, and it's a long way from bountiful future Wall Street expects. But the second scenario is far more daunting. It demonstrates the dastardly meanness in mean reversion.


The abnormally low real rates are the work of the Fed. They cannot last. Once demand for capital supplants money supply creation as the principal force driving rates, as it must, real rates are bound to rise sharply, restoring the trend that began in mid-2013. That's why the mean-reversion scenario is the most likely, if not inevitable, outcome. One scenario is fair, the other is poor, and the poor one will probably reign. The Wall Street pundits can't stop thanking the Fed. They should reconsider."

3) Stocks On The Precipice Of A Huge Move by Todd Harrison via Minyanville.com

"Neil Young famously sang, "I caught you knocking at my cellar door; I love you baby, can I have some more; ooh, ooh, the damage done."
The bears have repeatedly knocked on both sides of the cellar door that is S&P 1850 seventeen times as they tried to break out to the upside and another seven times as they tried to knock it back down.

"The first is the percentage of Russell 2000 stocks above their 200-week moving averages, which is at 40% (MKM Partners).  Historically, when that percentage reaches 40%, it was at or near an intermediate-term top in the index.  The second is the average return for the 1-, 3-, 6-month and 1-year periods following those events. Take a good look."


"History doesn't always repeat but it often rhymes, and after the insane run in the small caps and biotech stocks some perspective is an important context when mapping forward risk. As we often say, to fully understand where we are, we must understand how we got here."

4) Is This A Correction Or A Coming Crash? by Michael Gayed via MarketWatch

"Has the correction finally started? There are enough things happening behaviorally within the market to consider this. The deflation pulse, which has been a big theme of mine over the past year, remains alive and well. We must all ask ourselves why in the world Treasurys are so well bid when the Fed is stepping away from stimulus.


"Judge a man by his questions rather than his answers."



We must also ask ourselves why defensive sectors such as consumer staples, health care and utilities are leading. When low-beta areas of the market outperform, that tends to be a warning sign of coming volatility and a potential correction ahead for equities."

5) Keep Buying Or Get Out?by Martin Pelletier via Financial Post

Retail investors have a very bad habit of "buying high and selling low."  This is due to the combined effect of an always bullish media bias combined with the emotional flaw of greed.  However, retail investors generally lack the tools, information and discipline to identify major turning points in the market.  Martin makes some valid points about what "smart money " is doing and focuses on the single most important point.

"But it isn't the smart money doing the buying. Recent Bank of America research shows institutional clients have been large net sellers of stocks since mid-February despite receiving large inflows from investors.


Corporate insiders have also been hitting the sell button. As cited by Mark Hulbert, editor of Hulbert Financial Digest, officers and directors in recent weeks have on average been selling six shares of their company stock for every one that they bought. This is more than double the long-term adjusted ratio since 1990 and is the most pessimistic insiders have been in more than 25 years. The closest we've come to this level was in early 2007 and early 2011.

With the smart money exiting, who's behind the bids?


"Not surprisingly, average retail investors have been huge net buyers of stocks and stock funds since early June of last year. This trend has gained so much momentum that these investors now hold eight times as much money in bull funds compared to bear funds, setting a new all-time high.


If you are considering going all-in or, worse, leveraging up, we recommend taking a step back to examine what your long-term investment goals really are and measure them in the context of the current market environment. Moving away from the herd can help you avoid buying market tops and selling market bottoms.


Finally, remember that no one truly knows what is going to happen when pundits call for new highs or the next major correction. Your time is better spent focusing on what you can control and that is managing risk, because if history teaches us anything it’s that irrational behaviour works both ways."

Bonus Video:  WSJ Interviews Yale economist Dr. Robert Shiller on his thoughts about what actually drives markets.


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alangreedspank's picture

Perma bulls always have the upper hand. If they crash their firms losing all their clients' capital in an obvious bubble's explosion (that they might even have spotted themselves but kept quiet), they blame it on the market and their reputation is unscathed.

On the other hand, if contrarians tell their clients to cash out and wait it out, if they get their timing wrong, 6 months, a year, 2 year, their clients will take their money somewhere else to lose it there and said contrarian's reputation will be much more tarnished than if he'd stay the course.

WS is stupid.


NOTaREALmerican's picture

Re:  WS is stupid.

Well,  the casino got their money.   It's the gamblers who are the stupid ones. 

max2205's picture

The fed has had complete control over the markets for 5 years.....I'll do what the fed does

kurt's picture

The bouncy dick has got to go, please. Really.

LooseLee's picture

It is this attitude (conformity based on FEAR) that is all that is wrong in this country in particular and humanity in general. It is, like Jesus said, "The blind lead the blind and they all fall into the ditch". Good luck with your PINK COMMIE strategy....

alangreedspank's picture

Read my above comment and see why you're off base. Also, I don't like people playing Bruce Lee with other people's money. Jesus is not known for being a great investor either.

LooseLee's picture

It is this attitude (conformity based on FEAR) that is all that is wrong in this country in particular and humanity in general. It is, like Jesus said, "The blind lead the blind and they all fall into the ditch". Good luck with your PINKO COMMIE strategy....

css1971's picture

You can't know the future so you cover all bases. Hold everything; stocks, bonds, cash, commodities, property, domestic anf foreign, and when you buy, buy what is relatively the cheapest and twice a year you rebalance the ratios you've chosen.

Having said that I'm being a hypocrite at the moment, I cashed out 6-9 months ago because the risks are too high.

kurt's picture

Get a new avatar. Mr bouncy dick is too much. I Always, always skip your posts because I can't stand seeing it.

This goes more Mr. Who Beats His Face Bloody on the Keyboard... always, always skip.

This goes for swirly shit, gives me a headache... won't ever, ever read it... just move on by.

samcontrol's picture

seriously we all have bigger problems than the boucing dick avatar.

seek's picture

There's local mean reversions (short term) and historic mean reversions (long term, as in centuries). Both are coming.

This is why I'm not in the market and lay awake sleepless at night wondering what I've forgotten to do in the beans, bullets, band-aids realm of planning.

Deathrips's picture

I agree.


You are not alone.



MrSteve's picture

You will find truly useful info at this VITA site, along with great farming and technical development books, all free to download and store for future reference and current projects. A great resource: Square Foot Gardening, a great efficiency and effectiveness concept and you can eat it!


NOTaREALmerican's picture

Up n up n up n up until.....

Somebody big don't get paid.   

(need some music for this)

Philalethian's picture

"The problem is that most investors are blind to those dangers as they continue to follow the madness of crowds."

Yes, but that does not mean the crowds are blind to the madness. It is so easy to cut it all off at the roots by just staying home and refusing to spend, or participate in the taxation for warmongering politics by the profiteers of death and destruction. It is happening. The people are just saying no more. No more taxes paid. Save what you have, build your home base, reserve for later dayz. Got neighbors?

"Somebody big don't get paid."



Philalethian's picture

La musica tambien?

Up up up, up and away!


On a side note. Please help RBN if you can. Simply download the app at this site to do a lot for them. Please folks, donate if you can to this valuable source of truth.



MuleRider's picture

"Somebody big don't get paid."

Or we start running short of ass-wiping material, a la Venezuela.  Nothing gets things stirring quite like a spoiled, massive herd of sheep with shit all over what they thought was pristine wool. 

MrSteve's picture

I suggest the theme song from UNDERDOG.

mayhem_korner's picture



The fundamentals don't support the valuations.  But trying to time when the two will come into alignment again is a fool's errand. 

MuleRider's picture

The old axiom of lead (BTFD), follow (BTATFH), or GTFO the way is true and appropriate here as it ever was. 

Yen Cross's picture

   At least the Krugmanites can't blame the weather in Q-2. It's been quiet on the tornado front and hurricane season doesn't start until late August/September for the U.S.

   Who am I kidding? D.C. will find so cosmic event to explain the continued macro deterioration through Q-2...

Carl Popper's picture

I've lost more potential gains than I care to think about.  When the market doesn't make sense I get out.  


I could have had so much more money if I were clueless like my mom.   She looks like a genius dollar cost averaging over 30 years and never trying to time anything. 


Maybe I am the clueless one.  

NOTaREALmerican's picture

The optimists have always won.     It's what made America Merica.  

It's tough to be a pessimist here.

Midnight Rider's picture

The perceived genius of the permabull is only temporary. We haven't yet paid for the huge downside of the Fed's and other central banks recent "stimulus". I have no doubt we are currently at an unsustainable artificial high in the market. Remember, this is what the central banks were after, artificially high global equity markets in an attempt to get the flawed trickle down theory to work. Given the time and magnitude of the intervention, world GDP should be soaring, which it obviously isn't. So what are we left with? A slowing global GDP and massively higher debt levels to be paid for in the future with the remaining slowing GDP. Not a real rosy scenario. Unsustainable and a recipie for a significant reset in the not too distant future. Who knows when, but play the odds. Insiders are and are selling the heck out of their personal equity holdings who's prices they bid up using stock buybacks with company funds. The true suckers currently buying overvalued equities will eventually be clear. 

mccvilb's picture

You and your mother have different agendas and "skills." I'll wager your mother doesn't use margin or listen to CNBC either, therefore she can't be misled by financial pundits or market mythologists. If she can talk fast, sound out of breath and excited, read off a teleprompter, and bang on a cowbell or hit an ahhooga horn there may be a future for her in television. You too.

"Moar cowbell, Ma!"

RichardParker's picture

Bear or bull sentiment? Socialized .medicine, gas almost at 4$, real wages still declining, administration that promotes class warfare and wealth tax. Billions of free money pumped into market not to .mention no accountability. Gee I dunno. Lol

disabledvet's picture

I listen to the Fed and that want that dollar index at 30 not 90. that's calling for a drop in the dollar by 2/3rds "to get this economy moving."

needless to say "that's still not good enough for Wall Street." this mind you while "serious matters of State have come to the fore."

The USA did not ask for the Russians to go into Crymea. to suggest otherwise really is the height of insanity. The USA has been issued very blunt threats in public however..."just asking to be punched in the face."

this may in fact happen...and as if a reflex "America will respond."

the whole matter is just really a mess. "this is Europe's problem. now get ou of the way here we come."

my first instinct is "nuclear shooting gallery" actually. HOT heads are prevailing...and they're gonna "let loose."

If you folks think Russia going all in on Ukraine "is the answer" then you truly have gone over to the dark side. Putin can't hold that piece of real estate. He'll have an insurrection to put down immediately.

I'm talking HOT from the getgo.
if that happens the USA will be all in immediately and "Europe will either have to join in or be a sitting duck." France in particular actually. (a very powerful France I might add.)

my personal view...especially having been here for so long...is that Putin is now truly ready to "go for it."

if he does...this would truly be catastrophic.

Fire Angel's picture

Schiller is stoned out of his mind. Did anyone notice that except me? Fire Angel 

Midnight Rider's picture

That's typical Schiller... Always looks that way...

Clowns on Acid's picture

why don't these guys say "End the Fed" ? Well I would think that you all know why...