A Cautionary Tale For 2011

By December 30, 2010Weekly Writeup

Volatility is low and stock market uptrends are intact. Specifically, the price on the CBOE Volatility Index (VIX) is below its 50-day moving average, while the prices on SPDR S&P 500 Trust (SPY) and Vanguard Emerging Markets (VWO) remain comfortably above their near-term trendlines.

VIX 50

SPY 50

VWO 50

Nevertheless, I think it is important to provide subscribers with some words of cautious wisdom for 2011. Indeed, I am somewhat concerned about stock assets in the immediate-term.

Did the recent rate hike by China give me pause to reflect, or was it the unexpected decline in the latest consumer confidence reading? Has the extreme level of bullishness in the American Association of Individual Investors Sentiment Survey ruffled my shirt collar, or was it the steeper-than-expected drop in residential home prices? Is the fact that stocks are hitting higher highs on lower volume raising my eyebrows, or am I wary of crude oil closing near its highest price per barrel since October of 2008?

Nope… none of the above. (Maybe the AAII Sentiment Survey results are a bit disconcerting.) In fact, most of the above-mentioned items actually benefit market-based securities because they help asset prices climb the proverbial “Wall of Worry.”

Consider how powerful the “Wall of Worry” really is. In 2010, the world has battled fears regarding: (1) the collapse of the “euro-dollar,” (2) an inability of sovereign European nations to pay debts, (3) pervasive summertime, double-dip recession prognostications for the U.S. economy, (4) a perceived anti-business White House, (5) expiration of Bush tax cuts, (6) technical chart disasters like the Hindenburg, (7) market manipulation scandals like the “Flash Crash,” (8) Korea, Iran, and Afghanistan, (9) 10% unemployment, and (10) foreclosure fiasco a la rubber-stamping. In spite of it all, stocks and commodities (a.k.a. risk assets) witnessed super-strong, double-digit percentage gains this year.

Okay, so something got under my skin, didn’t it? Yes… but that something is a “someone.” His name is Baxter.

Having lost money in the dot-com collapse in 2000, and holding a deep-rooted antipathy towards Republicans, Baxter was one of the most bearish clients to join me in 2001. I made money for Baxter in small-cap value in 2001 and avoided equities in 2002. My conservative choices meshed with his “things are terrible” mentality. When technical and fundamental trends pointed to investing heavily in stocks and commodities and emerging markets in 2003, Baxter nearly pulled the plug on my money management authority. Every excuse in the book was on the table… from Bush to Iraq to deficits to joblessness to recession.

I proceeded to double Baxter’s accounts over the next 5 years and I protected him from the bulk of the 2008 financial collapse. Even as I made more money for him in 2009 and 2010, Baxter held firm to the same bearishness that had guided his thinking since 2000. True, he credits me with “saving him from himself.” But he also feels that his “bearishness” over the last decade was well-founded, even though we made money in the “lost decade.”

A few days ago, Baxter wrote to ask me if it might make sense to buy some shares of Citrix and Salesforce.com. The ultimate bear… born during dot-com despair… is now comfortable with individual securities? P/Es of 40+?

I explained that we had been faring quite well with First Trust Internet (FDN) and Rydex S&P Equal Weight Technology (RYT). And while that seemed to quell some of this new-found stock ardor, Baxter cited all of the rosy S&P 500 forecasts for year-end 2011 by the Goldman Sachs’s of the world.

I still anticipate a strong finish for 2011. And I still like funds like Rydex S&P Equal Weight Technology (RYT); indeed, I expect corporations to continue upgrading their networks, hardware, software and systems.

Yet the greed in Baxter’s voice is evidence enough for me to caution the complacent investor. Specifically, keep your stop-loss limit orders firmly in place!

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