Sunday Morning Coffee

A reader asked for my opinion about what sectors and countries to buy when the market eventually starts a new bullish phase.

OK so this has two parts to it in terms of how I try to frame the answer.

Long time readers may recall my saying that I try to combine what I know about market history with an assessment of current events to try to make a forward looking analysis.

An assessment of current events with an eye toward reequitizing becomes difficult because it may not make sense to reequitize for a year and a lot can change between now and then.

Starting from the top down it makes sense in a new bull market to reduce the average cap size of the portfolio (I made the portfolio larger and larger cap-wise as the bull aged) because small cap usually leads off the bottom. In making the portfolio smaller you are increasing the volatility which again makes sense to do as obviously the prevailing direction of a bull market is up. All of this probably reduces the yield a little bit but in a year where the market goes up 25%, squeezing out an extra 50 beeps in yield should not be the priority.

In terms of sector the first thing that comes to mind to overweight is industrials. Globally speaking money must flow into infrastructure so I believe industrial stocks that benefit from this capital flow stand to do well.

Financials would be another area that usually does well emerging from a bear. Problems at Citi are not new. After a the famous near death blow in the early 1990s Citi went up about 2000% versus 300% (just eyeballing a chart) for the SPX into year end 2000. Citi was not my fav before this all started and probably will not be after but the point is that the financial sector (the ones that survive) will come back from this and probably outperform meaningfully for a while.

Tech should be one to overweight but if I were reequitizing right now I would be skeptical of that one but we’ll see when the time comes.

Discretionary does well early cycle too. Energy is a tough call from a historical perspective as I think there are skews to each of the past episodes that make looking back especially unhelpful. Based on my perception of what is going on with supply and demand I would probably want to be overweight. Ditto materials.

Telecom equipment should do better than the ma bells of the world (and I do mean the world) but I am a little distrustful of making a big bet on that. Utilities, staples and healthcare would probably lag a little.

Most of this is based on how cycles work. I tried to add in a little current thinking in there but I think it will be a while before this matters and the manner in which the bear plays out will influence how I actually execute.

As far as countries I am not likely to make really big changes to the countries I favor. I have talked about adding China back in across the board at some point and I might add a little to a couple of the other countries I currently own. While that mind not sound like much keep in mind I have about 20% cash so at 2 or 3% per position it wouldn’t take much to reequitize.

The picture is obviously from South Beach last week. That hotel is on Ocean Drive and looks out on to the beach (where I am standing) and the ocean beyond that. Unlike most of the pictures I took I don’t hate this one.

11 Comments

  1. Roger, using the Ultra short ETF’s has me concerned with the derivative activity that creates the higher returns. Are you concerned with the ability of the funds, (QID, SDS), to cover volume outflows of a large nature when this market does indeed turn to the upside and people are closing their short positions? I enjoy your take on the markets and thank you for your reply.

    Reply
  2. the ETFs buy futures to manage their positions. If there is outflow from the funds they reduce their position size. If there is lots of interest in the ETFs they simply buy more futures contracts. I do not believe your concern will be an issue.
    However, just like any other large participator in the market their actions do affect the market. But that’s no different than what happens when people pile into or out of the SPY.

    Reply
  3. Good comments, but I am surprised you did not emphasize Asia more. In the short run I think they have as big of problems as we do, but I still see the balance of the world shifting to Asia this century.

    Although if the dollar really tanks I may have to rethink things.

    seg

    Reply
  4. dm, that does not concern me in the least for the reasons Sami said.

    SEG, i mentioned china, i have one stock from singapore on my radar and i would be interested in the sing dollar if there is every a product for it.

    Reply
  5. FWIW, I’ll be looking to wade into the sectors mentioned via the proshares ultra etf’s. Comments on why this is/isn’t a good strategy are welcome.

    Go Davidson!

    Reply
  6. Hey Roger,

    I watched your Saturday video yesterday, and noted your comments about the market (FWIW, I’m basically on the same page).

    Anyways, just finished up reading Hussman’s weekly commentary, and here is an excerpt:

    http://www.hussman.net/wmc/wmc080331.htm

    Generally speaking, it is true that the stock market has tended to bottom about 4-5 months before the end of a recession. It is quite dangerous, however, to assume that the current downturn in the market or the economy will be of a specific duration, and to start “looking for a bottom” on that basis. Just as market tops are marked by expectations that economic strength will persist indefinitely, stock markets hit bottom when an economic downturn is taken as full fact, when conditions are widely expected to get substantially worse, and when investors have largely given up on any hope that the economy will improve in the foreseeable future.

    My impression is that the early calls for a bottom ignore a realistic sense of history about how market peaks and troughs are formed. Once an ongoing and worsening recession is taken as a matter of common knowledge, it will be reasonable to talk about durable market lows. Until then, investors should recognize that a standard run-of-the-mill bear market averages a loss of about 30%.

    Maybe he is taking material from you 🙂

    Reply
  7. to the Davidson fan, the answer is it depends.

    if you have $1 in your account and plan to put $0.50 into some combo of double long funds anf keep the other $0.50 in cash then I would ask what time period you expect to do that. Look at a chart for 2007 comparing SPY and the ProShares Double Long S&P 500 ETF. The double long lagged for the year.

    Over longer periods of time you don’t know what you will get.

    If you are looking to put every nickel into double long funds then you are essentially on margin except there is no margin clerk who will force you to sell.

    going all in with double long funds is not for me, if you want to do it, have some sort of exit strategy defined before you go in.

    Mike C, i think it is a good bet that Dr Hussman does not have this site on his list of sites to read, lol.

    Reply
  8. Roger,

    I admit you recognize china and clearly identified it. All your comments were good.

    I just thought you might have jumped into Asia with both feet. Of course both feet is a little different for the two of us 🙂

    seg

    Reply
  9. “Mike C, i think it is a good bet that Dr Hussman does not have this site on his list of sites to read, lol.”

    I love your humor and I am not shy about disagreeing with you. But, I hate when you sell your self short. You really do a rather good job IMO.

    seg

    Reply
  10. We hate to add to what we consider a pretty gloomy prospect, but Tilton takes care to note that the $460 billion that Goldman expects to go down the drain is “only part of total credit losses,” which it anticipates will reach a tidy $1.2 trillion. However, he explains, the leveraged losses are especially critical, as they cause a significant tightening of credit as institutions curb their lending to conserve shrinking capital. Which, for us, anyway, makes the tunnel a lot longer and the light a lot dimmer.”

    Above from Barry’s site and the 1.2 trillion estimate is from Goldman.

    I guess those trillion dollar loss estimates are not crazy, gaining credibility, and may have been slightly on the low side.

    seg

    Reply

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Sunday Morning Coffee

A reader asked for my opinion about what sectors and countries to buy when the market eventually starts a new bullish phase.

OK so this has two parts to it in terms of how I try to frame the answer.

Long time readers may recall my saying that I try to combine what I know about market history with an assessment of current events to try to make a forward looking analysis.

An assessment of current events with an eye toward reequitizing becomes difficult because it may not make sense to reequitize for a year and a lot can change between now and then.

Starting from the top down it makes sense in a new bull market to reduce the average cap size of the portfolio (I made the portfolio larger and larger cap-wise as the bull aged) because small cap usually leads off the bottom. In making the portfolio smaller you are increasing the volatility which again makes sense to do as obviously the prevailing direction of a bull market is up. All of this probably reduces the yield a little bit but in a year where the market goes up 25%, squeezing out an extra 50 beeps in yield should not be the priority.

In terms of sector the first thing that comes to mind to overweight is industrials. Globally speaking money must flow into infrastructure so I believe industrial stocks that benefit from this capital flow stand to do well.

Financials would be another area that usually does well emerging from a bear. Problems at Citi are not new. After a the famous near death blow in the early 1990s Citi went up about 2000% versus 300% (just eyeballing a chart) for the SPX into year end 2000. Citi was not my fav before this all started and probably will not be after but the point is that the financial sector (the ones that survive) will come back from this and probably outperform meaningfully for a while.

Tech should be one to overweight but if I were reequitizing right now I would be skeptical of that one but we’ll see when the time comes.

Discretionary does well early cycle too. Energy is a tough call from a historical perspective as I think there are skews to each of the past episodes that make looking back especially unhelpful. Based on my perception of what is going on with supply and demand I would probably want to be overweight. Ditto materials.

Telecom equipment should do better than the ma bells of the world (and I do mean the world) but I am a little distrustful of making a big bet on that. Utilities, staples and healthcare would probably lag a little.

Most of this is based on how cycles work. I tried to add in a little current thinking in there but I think it will be a while before this matters and the manner in which the bear plays out will influence how I actually execute.

As far as countries I am not likely to make really big changes to the countries I favor. I have talked about adding China back in across the board at some point and I might add a little to a couple of the other countries I currently own. While that mind not sound like much keep in mind I have about 20% cash so at 2 or 3% per position it wouldn’t take much to reequitize.

The picture is obviously from South Beach last week. That hotel is on Ocean Drive and looks out on to the beach (where I am standing) and the ocean beyond that. Unlike most of the pictures I took I don’t hate this one.

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