Yesterday’s (May 6th, 2010) Market Action and the Real Reason for the Fall
Stock markets fell sharply yesterday (see below) with the DJIA (Dow) falling nearly 1000 points intra-day. The market rallied back from the extreme losses but still closed the day down over 3% for the major indices on record level volume. You probably saw various headlines like: “Markets fall on European Debt Fears”, “Stock Markets Plunge on Trading Error” and “Markets Baffle Investors with Sharp Dive”. Although we believe the European sovereign debt fears are legitimate and there was a possibility that there was a trading error, we do not believe that to be the reason for the plunge of the market. Journalists want to point every market move to a catalyst that is taking place on the same day that the markets make their move. We believe the real reason for the fall was the stock market ran too far too fast and investors became overly complacent. When investors become complacent that means that they don’t fear a market drop. If investors don’t believe the market will drop then they will allocate the majority of their investment funds into the stock market. Once all their funds are invested then there is nothing left for them to do except hold on or sell. This will happen on a mass scale and effectively dry up all the demand (potential buyers). Once there is no one left to buy then the stock market will have a difficult time going higher which inevitably leads to the market being vulnerable to a sharp decline, like we saw yesterday. Computer trading programs can increase the markets moves in both directions, but the reason the markets fell was that people became too complacent and overly invested and that leaves no other option to sell at some point.
Market Conditions and Strategy Going Forward
We have been expressing for months that levels of complacency have become too high and the market is vulnerable to a sharp pullback. Other statistics that cause concern for us are the high level of insider sales to insider buys, near record levels of amateur money flows into mutual funds, lower levels of money market funds, overly bullish sentiment and high levels of margin debt. We believe yesterday’s move was just the beginning and we have positioned our assets accordingly months and weeks prior to today’s move. Our actively managed accounts hold over 50% cash and our passively managed accounts hold much higher levels of cash than normal. We have been invested in long-term U.S. Treasuries and Zero coupon bonds that have benefited from the market’s recent fears. In general, in our passively managed accounts we have lessened our exposure to riskier assets and invested in more domestic large cap that have historically held up better in bear markets. In our actively traded accounts we have a small short (inverse ETF) position in international markets (EAFE) that has appreciated as international markets have gone down. Most of our actively traded accounts were flat to up yesterday. After having terrific performance in our actively traded accounts for 2009 we have lagged the markets a bit in 2010. We have purposely been postured for a market correction as we believe the markets are extremely vulnerable for a significant decline. Going forward we plan on staying defensive, at the same time we are looking to take advantage of any hysterical selling by making small purchases in investments we believe will rebound quickly.
Allgen’s Investment Approach
Allgen specializes in active money management. Through technical and fundamental analysis, along with a contrarian mindset, we strive to navigate the markets during periods of prosperity and/or decline. We constantly research and study the markets to find the next emerging area even in asset classes that are typically not used in your “buy and hold” asset allocation portfolios. During the good times we focus on strength, and during the bad times we try to preserve wealth. During periods of stagnation, such as we are experiencing now and potentially years to come, we see ample opportunities to take advantage of this market. If you want to see how active money management may fit into your overall investment portfolio then please email us advisors@allgenfinancial.com or give us a call at 1-888-6ALLGEN (625-5436).
Written By:
Jason Martin, CFP®, CMT
Senior Partner & Chief Investment Officer
Allgen Financial Services, Inc.
martin@allgenfinancial.com
888.6ALLGEN
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