{Reminder: this was written a couple years ago, since then things have begun to look more encouraging with regard to housing. Market conditions have changed as well but I thought some of this might be helpful anyway. -RM}

The market is not the economy. The market is a humbling beast, and it is based on the expectations of every active investor in the global economy. Do not argue with it, do not proclaim to be smarter than it, and do not try to predict what it is going to do. Do not buy solely on fundamentals, (i.e., this stock is undervalued by some measure and eventually it will be worth more). It could be “undervalued” for a reason; institutional investors dumped shares because they saw it as an undesirable place to grow their money. Supply and demand. More sellers than buyers mean downward pressure on prices. If the technicals do not confirm your fundamental hypothesis, wait until they do before you initiate a position.

Prime example: housing stocks. People buy these because they think they will turn around. Really? Based on what? The technical picture is not there, and trust that there is very little demand for new housing starts, and the situation will remain that way for quite some time. How many newly built homes are vacant? How many existing homes are back on the market in the form of foreclosures? Where are the buyers? How long will it take to close this gap and justify building new homes? Could be many, many years, my friend.

The broad stock market indices are remarkably strong on a technical basis right now. I wouldn’t be short this market in a million years. We are due for a near-term correction, but we have been due for quite awhile and the market keeps grinding higher. If that first obvious level of support is taken out, it opens the door for a larger move down. There’s an old saying… stocks, and in turn, their markets, go up like escalators and down like elevators… so my point is, given the run up we’ve seen, given that the past few months have lacked super-impressive volume to confirm the up-trend and create a reliable floor, a quick correction could very quickly build on itself and bring the markets down significantly more until longer-term support is found. In absence of that downside momentum snowballing into something bigger, a “healthy, run of the mill” correction (4-6% on the indexes) would prove to be a good buying opportunity. Given, of course that the market continues to show strength at critical points. It should be understood that there is quite a lot of money expected to eventually be coming back into the market, into so-called “risk assets.” It should also be understood that these particular investors, the institutions who move markets, play things very close to the chest. They know they move markets, so they move like ninjas – with stealth and with great power.

The market, on occasion, will show you its hand though. However, we see that most advisors don’t watch closely enough to pick up on this stuff. That’s understandable… lots of financial advisors don’t actually want to be responsible for making all the investment decisions with your money. They pass your assets off to a third party manager – a mutual fund (MF), managed account or variable annuity (VA.) And then they go off and try to find the next client. Less stress for them, less accountability and higher commissions when considering MFs and VAs compared to equities. When they make moves, they make them en masse with your money. They call it “re-allocating” or a “quarterly re-balancing”. They select a few ideas, and then put all of your money into them. If the advisor is commission-based, not fee-based, this ensures that at least four times a year they will have big commission months. For you this creates huge positions with correspondingly large losses if they are not right from the gate. When things go wrong, they simply talk to you for a few minutes about weathering the storm, manipulate your expectations by extending the time horizon, and go right back to looking for new assets to bring in. It’s the classic example of asset gathering versus money management. What often happens then is continued denial, a shift in sells rules to allow the manager to be right…. eventually. And then, only after staring a 20-30% loss in the face for a couple of quarters, on large positions, do they realize they might have been wrong. That’s when one more piece of bad news hits the wire, a small panic sets in, clouds their reason beyond repair, and bad things happen. Either an immediate panic sell, realizing a much larger loss than could have been avoided with proper discipline, or a shift to “longer-term outlook”, creating dead money. The best move is often the first move; the worst move is often doing nothing.

RM ~Feb 2011