Let This Be Your Warning

Thankfully my parents taught me to hope for the best but be prepared for the worst. There are two very important distinctions that must be made to truly understand this credo. Hope is to wish for the outcome you desire or stated another way, to yearn for the most favorable results given your circumstances. However it must be noted that hopes, yearning, and wishes do not make events happen. They are passive in nature. The second part of this gem of advice is to be prepared or to take action against the possibility of the most horrible situation from occurring. To prepare means being equipped or readiness. Preparation is controllable; it requires effort and planning. Everyone has the ability to get ready for action. Preparedness is to be proactive.

Investors today need to understand that markets are signaling a possible crash! Now I am not saying it will crash, although in my opinion, the markets are sure leaning in that direction. However, there is a coordinated global government effort, with unlimited resources to print money and spin news in any fashion they desire, to avoid the possibility of that kind of negative event from occurring. But, to depend outside forces that may or may not work to save your portfolio is to hope without action. To ignore the markets warnings and not reduce exposure or set stop losses (that should have been set a long time ago) is to not attempt to determine your own fate.

No one can control the markets, but you can control your risk. You are empowered to determine the amount of risk that you are willing to take. Great portfolio managers are not people who just know how to pick winners. Believe me no one is even close to being right all the time. Picking securities that go up is less than half the equation. Successful investors have realized that the most important aspect of managing money is to manage the risk! The markets are staging another waterfall event here. The markets are down 10% in just the last two weeks. Historically, all big losses started as small losses that were left unchecked.

A look at any chart of the major market indices will clearly show that the uptrend from March 2009 has been broken. First support, is somewhere between 875 and 950 for the S&P 500. Is that the worst? Absolutely not! As stated that is first support – not worst support from here. I understand the case for 666 to be tested in the near future, but I hope against all hope that we never see those levels again in my lifetime, because if we do, the “real world” will be pretty dismal. Therefore I am recommending protective measures be taken at this time.

We cannot ignore some awful facts about our current economic situation. For starters the global solution to the debt problems created over boom years has been to create more debt. Commons sense says that to solve a crisis of too much debt would be to become more fiscally responsible. Cut spending, increase savings, and reduce liabilities seems reasonable to me. The next area that has not yet been addressed is allowing institutions that ran amuck to fail. Yes, Lehman failed, but what about AIG, Bear Stearns, Fannie Mae, Freddie Mac and a huge list of other institutions. They all got bailed out in one form or another. Now the lifeguards, who saved these organizations, need saving themselves as many Sovereign nations are drowning in their own debt, including 40 of our own 50 states right here in the good ole US of A.

Initial claims for unemployment are rising once again, as is continuing claims for benefits. The elevated level regrettably suggests continued weakness on the jobs front. The Labor Department indicated today that 3.3 million people will lose unemployment benefits by the end of July- which will lower the unemployment rate, as those figures only include those poor souls collecting benefits. How are those people going to help the economy grow? The housing numbers are even more stark. Today’s pending home sales figures showed a 30% month-over-month drop for May. In case you’re not sure, that is a dramatic decline and indicates a potential further plunge for home prices despite record low mortgage rates.

Another example of the rush to safety is the falling yield on the benchmark 10-year Treasury Note. It is now below 2.9% for the first time since April of 2009. Yield and price are inverse to each other. Investors buy the price. As demand goes up, prices rise because they can (think about an auction – if several people wanted to buy your used car you would sell it to the highest bidder). Therefore as Treasury prices rise, the yields drop. Treasuries are thought to be the safest investment vehicles available. At current yields, one can deduce that the demand for safety is at a premium.

The recent selling in the Dow Industrials and the Transports has produced a Dow Theory sell signal. This is a more than 100 year old indicator that is now calling for a further decline in the markets. The S&P appears to have broken the head and shoulders formation that I have previously written about. Measuring from the top of the head to the neckline is about 179 points. Employing traditional technical methods, it projects to a possible S&P level of around 860. The Dow and the NASDAQ have also broken their head and shoulder formations. From both a fundamental and technical read, the markets are on very shaky ground. Put simply, this is the worst, and most dangerous times for the stock market I have seen since my early days as an investment advisor back in 1987. Long after the crash of ’87 people claimed that you could not see it coming. I disagree – yes you could have anticipated that danger lie ahead, just as you can today. Like today, the markets had dropped over 10% before the crash in 1987. It doesn’t mean we could identify the exact timing and magnitude of the drop, then or now, but it is in times like this that you should prepare your portfolio for a potentially huge negative outcome.

There are a couple of positives: The last two weeks of vicious selling has produced a marked oversold condition for stocks and a reflex rally could pop up soon. I would use those rallies to lighten up. The dollar/euro relationship may be turning, as the Euro is inexplicitly up today. There has been a direct relationship with our stock market and the Euro. Recently they both have been moving in the same direction. If the Euro rallies here in the short term, our markets could as well.

I hear many pundits talking about the markets today representing good values. Valuation is a very slippery slope. Historically coming out of a recession stocks trade at 11- 14 times earnings. Bad recessions have put PE ratios well below 10. In 1974 at the bottom of a terrible market, but one not quite as bad as ours has been, the PE went as low as seven. Today’s PE ratio is around 15 times earnings – fairly high from a historical perspective given the end of a recession. Investor risk appetite is a fickle item to attempt to quantify. Your own risk tolerance is what you should focus on.

Sometimes to win is to not lose. If you’re like me, and are absolutely insistent on not losing, then doing the work it takes to be prepared to position your portfolio for the winning side of things is imperative. If you thought 2008 was a tough year, there is a very real possibility that the coming period could be equally as difficult! How fast you recognize that, and react accordingly, may very well be the difference between having funds for your retirement or not. Let’s all hope for the best, but also recognize that Hope is not a strategy!