The “State of the Market” Address

Week One of Q3 Earnings

This week marks the first week of critical earnings results for the 3rd Quarter.  This is one of the most critical times I’ve seen in the financial markets in quite some time.  Why?  Because of the pervasive optimism by so many that, for the first time in history, it is possible to literally borrow and spend out of a great economic downturn.  As you probably know, I am not in that camp.  Never have been.  Perhaps it’s because I’m a simple guy…or perhaps it’s because I’m just missing a critical piece of information that would help me make sense of things.  But either way, I do not understand how borrowing more and more money (which is not free…and which will ultimately have to be paid back — with interest!!!) will ultimately result in less leverage.

(And a nod to the policy wonks: Yes, I do get the idea of driving down the Dollar to borrow cheap, then re-inflating the Dollar to buy back that Dollar-denominated debt with a stronger Dollar and effectively screwing your creditors.  But for a myriad reasons, that will not work this time.)

To my way of thinking, our current quadrupling of the national debt is tantamount to opening up one new revolving credit account after another for the sole purpose of making the minimum payment on the last card…which is maxed out!  At some point, the music stops and there is no chair to sit on.

No one has been able to explain to this admitted simpleton the underlying rationale for doing what we are doing.  In fact, the only thing that makes sense is that our leaders are doing what they have always done…for decades upon decades (this is not a new phenomenon): Perpetuate a never-ending game of “Kick the Can” to the next generation.

So is it all bad?  No!!!  Ultimately, there is a short-term silver lining to this impending fiasco, and one that we can exploit for our own self-interest!

It’s good for equities!!!!

On Friday, I chatted with Larry Kudlow about the current state of the market.  If you recall, I’ve been keeping a close watch on the levels of the S&P, noting that a failure to push above the September highs would really create some problems.  Well, Friday’s higher close surprised a lot of people.  In fact, Larry’s producer called me after the market closed for the express purpose of discussing why the market closed higher.  Everybody had been expecting a big pullback!

If you watch the video, you’ll get my take.  As a function of live TV, it was incomplete and imperfect (Did I really say “the sky is the limit”???  Geez…that’s a soundbite I’ll live to regret).  I do enjoy being on Larry’s show because it is perhaps the only time when I get an opportunity to express an opinion rather than fight for the next 15 seconds while a producer chirps “C’mon…get in there!!” in my ear. 

Thoughtful conversation is interesting; soundbite jousting matches…not so much.

But the gist of my message (which was not all discussed due to time constraints — see Point 3 below) was this:

1. As long as the Dollar continues to fall, equities will be the place to be.  Yes, at some point it will become a problem for the market…but I sure don’t see that happening before the Dollar falls below the 2008 lows and threatens to become the American Peso (no offense to our friends from south of the border).
2. With the personal savings rate on the rise, there will be a steady stream of money into the market (it’s not all put in a coffee can and buried in the back yard). 
3. Assuming the market continues to lift (not a certainty…but there is no sign that the underlying bid that has propped up this market is waning), we are on the verge of a positive feedback loop — the inverse of the one that dragged down the market.  That is, a rising market will have a positive impact on the psyche of the individual investor who felt burned last year, and who has largely been out of the market for fear that it will crash again.  Ultimately, these folks will regain their confidence and start putting their money to work under the “better late than never” approach.  And that 11th hour money will push the market even higher — ultimately sucking the majority of individual investors back into the market right at the high! 
4. Once the lowest common denominator is back in the market, valuation once again gains its rightful place at the top of the priority list and we will then see a market high and equities will decline.  The result will be a pervasive sense by the investing public that they’ve been hoodwinked by Wall Street once again!  Not so — they’ll have done it to themselves.  Not deliberately…but because of a fundamental ignorance about how markets, money, and investor psychology actually work.

Don’t fall prey to these challenges.  Instead, arm yourself with objectivity and fact-based trading/investing decisions.  Be agnostic!!!  Unless you’re on the pulpit or running for office, you don’t have to convince anyone of anything.  You don’t have to be “right”; nor must you “stick to your guns” until you are “vindicated”!!  Instead, just make money. 

As I mentioned repeatedly in last weekend’s 200 strong “59-Minute Trader” class, trading is really not that hard.  We just make it hard because we are trying to make it something that it is not.  We instinctively want to inject some sense of certainty into the equation.  That’s impossible…and you know in your gut that it is impossible!  This is “speculation” (Look it up!), it is not “money harvesting”.  Trading is rife with uncertainty.  And once you understand and embrace that component of trading…it is not so hard.

The one thing that we do have ultimate control over is the degree of risk we take on.  That is why I’ll say, once again, that we are not traders here; we are risk managers!!!

Now, let’s manage some risk.

–Dan

Members:  Check out the Weekend Update here.  Set aside some time, because we’ve got about 60 minutes of video analysis.