(Please enjoy this updated version of investment insights from the Reitmeister Total Return newsletter).
The FOMO is thick this week. You can feel the pressure to join the rally as the market continues to surge.
Certainly we talked about this in recent commentary. Especially last week’s commentary where I envisioned the market attempting to breakout, but likely failing. That is why I stated that we needed to resist joining the rally for the first few sessions above 3,000 to make sure make sure it was truly a breakout…and not a fake out before going lower.
However, I also considered the possibility that indeed the rally could extend and it would be in our best interest to join in. (Probably a good idea to read that last week’s commentary now if you have not already to get up to speed on that game plan: Beware 3000 on S&P?)
The central thesis of all this is that we are in the midst of the worst economic event since the Great Depression. Yes, even worse than the Financial Crisis and Great Recession of 2008/2009 as economic readings are much lower. And job loss much greater. And the pain of that job loss and lower income has barely begun. So it’s hard to contemplate stock prices this high, this soon when the economy and corporate earnings will be so low, for so long.
Then add on top that there is no historical V pattern for a bear market. Typically bottom is a long period of retesting bottom or even finding lower bottoms over a 6-18 month period before the next healthy bull market emerges.
And yet with all that sound logic in place, and the vast majority of experts still bearish, here we are with stock prices 38% above the late March lows and only 11% below the all time highs. At first it was easy to say bear market rally. But the longer it stays in place, and the higher it goes, that argument is starting to lose steam.
So that gets us back around to the possibility that I could be wrong. That this is not a bear market rally. Instead it could be the next bull market that should compel us to a much more aggressively long portfolio.
As stated in the introduction, I will try and review this possibility with as little ego involved as possible. That is because I want the next step for us to be as profitable as possible. And if that means admitting failure and shedding the bear suit…then that that is what I will do.
So with that disclaimer fully in place I can say without reservation that the economy will continue to be horrible for the rest of the year. And likely that pain extends into 2021 and possibility beyond depending on how long the Coronavirus continues to be a daily threat. Meaning the odds of me being wrong on the economic outlook is incredibly low. Like truly single digits % possibility that I misunderstood those signals.
Unfortunately it is also true that the stock market can disconnect from the harsh economic realities and continue higher. That happens all the time when you appreciate how the pendulum swings from fear to greed. And at each extreme the market disconnects from the fundamentals.
In fact, this same idea is at the root of all equity bubbles. And as we saw with the tech bubble of the late 1990’s and the real estate bubble leading up to the financial crisis in 2008…bubbles can last for a surprisingly long time.
Back to the main point. I want to review the main possibilities of what happens from here and how that would change our investing strategy from where we stand today.
Most Likely Scenario = Bear Market Rally
Remember that I have an economics background while most money managers and computer/quant traders do not. And so my reading of the economic chain of events is better than most.
Sorry if that sounds like a brag. Not meant to be. Just a statement of my strengths…which right now is my weakness.
And the reason it’s a weakness is that I look at the business cycle (boom and bust) as the True North of investing which makes current price action a distant second consideration. NORMALLY that serves me well. But in this case it clearly led us to missing out on some nice upside. Even if that upward move was misguided or temporary.
So for me, there is no change to the bleak economic outlook that will not blow away any time soon. And that is true EVEN if everyone on the planet got a vaccine in June. Because it is no longer just about the virus. It has already pushed over into being an economic crisis that has a trajectory all its own. And again, for me that path is down for quite some time. (job loss > lower spending > lower corporate profits > more cost cutting like more job loss and the vicious cycle continues lower).
All of this SHOULD become evident to others in time and stock prices head lower.
Is that now as we battle with 3,000?
Or a week from now? Or a month?
Nobody knows. But this return to sanity…where the trend of the economy, corporate profits and stock prices are connected, should come to life at some stage. If that happens soon, then you already know my prescribed strategy for this outcome…which is the strategy that is already in place for the RTR service.
But yes, this is all tenuous because if the breakout above 3,000 rolls into next week then I will be compelled to join the rally. The strategy for that is best described after all 3 scenarios are laid out.
2nd Most Likely Scenario = Long Term Trading Range as Bridge to Future Bull
I contemplated this scenario in my 5/15 article on StockNews.com: Is This a Bull or Bear Market?
The nutshell of this argument is that bulls and bears may wrestle this out for a long time and we play in a pretty wide trading range. We all know the bearish argument. But the key to this range is what the bulls are thinking. Let me share that with you now:
“Whereas bulls will say they are not blind to the current problems. Instead they are just looking out to a longer term horizon where the economy gets back on track. Add in unprecedented Fed and Government stimulus and they see it propping up share values.”
Read that last paragraph again because there is a lot of meat to this concept. Because indeed that may be the main theme behind the recent rally and why it disconnected from obvious economic realities. And these investors may not care how long they have to wait for a true economic rebound because with rates this low, then investments in stocks may still be better than cash or bonds which pay virtually nothing.
I believe there is a limit to the upside in this range. Maybe 3,100. And then we trade up and down for a long time in the range until it is crystal clear how we emerge. Meaning if economy getting back on track, then keep heading higher. But if it is true that the economy does not spring back to life as expected, probably because of severe job loss and lower spending, then stocks will probably head much lower.
I am not 100% sure the size/shape of the range. But for now let’s say a healthy 20% range like 2600 to 3100. This gives plenty of room for the volatile run ups and run downs we have seen the last 3 months.
If this is what emerges, then no benefit in being net short. More likely you go 30% to 70% long depending where you are at in the range. Meaning a lower % at top of range then buy the dips. The key is stock selection to find outperformance. That leads us back to my favorite hobby of picking stocks that blend an improving growth outlook with attractive valuation.
3rd Most Likely Scenario = This Bubble Grows Larger, Then POP!
Here we have a continuation of the theme that the market remains disconnected from the dismal economic realities. And given that so many people are still bearish, then you could explode above 3,000 with all the FOMO players getting on board. And indeed we would be one of them (but sometimes better late than never).
With bubbles you never know how high…or high long they will go. But typically it is an extreme level beyond what you could imagine. For now let’s say 3,500…heck it could be 4,000. That would be near a crazy high PE of over 30 given the newly lowered earnings estimates.
The strategy here would be to ratchet up to 100% long in the most Risk On names to mop up the most upside gains (airlines, oil, restaurants, hotels, banks etc). But here is the real key…
SLEEP WITH ONE EYE OPEN waiting for the bubble to burst.
Meaning you hold your nose joining the rally that you never really believed had any merit to begin with. This will keep you sober enough to be one of the first investors out the door when the bubble bursts and prepared for the downside that ensues. Whereas most others will be asleep at the wheel drunken with “irrational exuberance” leading to heavy losses.
Now we wait for the cards to be dealt out. Right now we are focused on scenario #1 where we expect this breakout not to hold for which our 32.5% short portfolio is perfectly built to thrive.
The funny thing about this seeming breakout above 3,000 is that Risk On stocks are falling. In fact, Thursday and Friday the airlines along with oil and banks all headed lower. Even the Russell 2000 of small cap stocks is down -3% the past two sessions. And in those same two sessions the Reitmeister Total Return portfolio actually rallied +2.65%.
So right now I expect this seeming breakout to fade away given the very Risk Off action the past two sessions. But if surprisingly the breakout continues into next week, and becomes more Risk On in nature, then we would be compelled to roll into scenario #2.
This is where it is probably a trading range and need to participate in the rally and be at least 30%+ long. And if explore lower in the range, then add more stocks.
Lastly, if stocks did continue to advance unabated, then you have to assume it is a bubble as stated in scenario #3 and you keep adding more exposure to get to 100% long.
We know the odds. And know the strategies for each turning of the cards. Now we just have to wait for Mr. Market to deal them out.
What to Do Next?
Yes, these are unprecedented times. And thus it should not be a surprise that the market is moving in unprecedent fashion.
So if you are having success navigating these choppy waters, then more power to you!
However, if you are struggling to know the right way forward, then consider checking out my Reitmeister Total Return newsletter. This is where I lay out in full detail why the current balance out risk and reward it points to being bearish at this time. Which led me to create this portfolio that is 32.5% short the market. This portfolio includes:
- 3 stocks uniquely attractive in this sluggish environment
- 1 Gold ETF because when there is a crisis and the world governments are in a race to devalue their currencies, then gold typically rises.
- 3 Inverse ETFs to mop up profits on the downside. And no, shorting the S&P 500 is not one of the selections. That is too conservative. These 3 inverse ETFs will gain much more as the market tumbles.
If you would like to see more of my market commentary and the hand-picked portfolio of 3 stocks and 4 ETFs and game plan to get bullish when the time is finally right, then learn more by clicking below.
Wishing you a world of investment success!
…but everyone calls me Reity (pronounced “Righty”)
CEO, Stock News Network and Editor, Reitmeister Total Return
SPY shares were trading at $304.32 per share on Friday afternoon, up $1.35 (+0.45%). Year-to-date, SPY has declined -4.89%, versus a -4.89% rise in the benchmark S&P 500 index during the same period.
About the Author: Steve Reitmeister
Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks. More...
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