Investment strategist and author, Ned Davis, wrote a great book back in 1991 called, Being Right or Making Money.What Ned Davis says he learned back then was the importance of not fighting trends, that you could be 100% right and not make any money if you bet against a market that ignored your thesis. In essence, Ned Davis learned not to throw one’s diligent work out the door but to also learn to be in harmony with the market and not to fight a trend. For the past six months many investors have been fighting the tape and waiting for the next big crash like the one that occurred in 2008. The market crash crowd may be right some day, but in the mean time they are not making any money and are actually losing money if they are shorting the market. Rather than try and jump ahead of the trend it is often better to stick with it, and that’s what I would suggest readers do, don’t fight the trend but stay open minded and nimble.
Commenting on this very concept was a post Barry Ritholtz did in his The Big Picture blog back in October of this year and I’d like to paste an excerpt from his post below:
Do You Wanna Be Right, or Do You Wanna Make Money?
My inbox is deluged with rants and demands from people who are insisting that This. Rally. Must. End. NOW!
A composite of their emails would read something like this: “How can you sit there so blithely while the Fed debases the world’s reserve currency? Why haven’t you commented on POMO?!? The entire game is rigged, and your just another @%$# salesman for Wall Street!”
Ahem.
My day job is working in an asset management firm. From that perch, I look at the world as a series of risks and opportunities. I am not a political analyst, nor a professional Fed critic. If through my research and analysis I come to a conclusion about a given issue — Bailouts, Fin Reform, Foreclosures, Stimulus — I am happy to share them.
But make sure you understand this much: I consider many other factors beyond the macro. This includes sentiment data, liquidity, market breadth, trend, volume, and valuation. And while liquidity can mean many things, this cycle its been pretty much all Fed all the time. That was what hedge fund manager David Tepper was referring to when he noted the Fed was pouring fuel on the fire. When the Fed sends their minions out to discuss the Bernanke Put, they add even more gasoline to the conflagration.
Some people rush for the fire hoses, but my job requires me to grab some marshmallows and sticks and head over to the boy scout jamboree campfire.
If you are constantly fighting the tape, if you missed the run up and are now whining about it, let me steer you to esteemed technician Ned Davis of NDR. In his 1991 book Being Right or Making Money, Davis tells the story of missing trades, investments and rallies because they did not fit some expectations of his regarding the economy or valuations or other factors. The title of his book and of this post comes from a more senior trader, who simply asked him: “Do You Wanna Be Right, or Do You Wanna Make Money?”
I couldn’t agree more with both Barry Ritholtz and Ned Davis. Back in 2006 I saw the economic wheel turning in the U.S. and felt we’d be in a recession by late 2006 or early 2007, and my case for such an outcome was laid in the article, “Running Out of Fuel.” I was a bit early but part of that came from failing to realize what the end of an interest rate cycle meant to financial markets and businesses. While things in 2006 were not particularly any stronger than where they were in 2007 as we were heading towards a recession, speculative fevers ran wild as the carry trade was on and investors across the globe chased speculative assets higher into 2007. What helped spark speculative fevers globally? Fed Chairman Ben Bernanke in the summer of 2006 held interest rates steady at 5.25% when the Fed had been hiking rates for two years. From the summer lows of 2006 to the 2007 top the S&P 500 rallied nearly 30% and anyone holding to their bearish housing calls, while they were right, did not make money shorting the broad stock market.
Things changed in 2007 as the credit crisis was beginning to brew when Bernanke cut interest rates for the first time since 2003. Markets initially rallied into the October 2007 high but even lower interest rates couldn’t kick the can down the road far enough and the markets rolled over. By the spring of 2008 both the 2006 end to the interest rate hike cycle and the 2007 interest rate cut induced rallies had been unwound. The 2006 Fed move to keep rates on hold led to nearly a 27% rally into the 2007 summer peak, and the next fed move, an interest rate cut in September 2007, led to just over a 6% rally after the news before the markets peaked out. In essence, the second big Fed move had a lot less bang for the buck and the true fundamentals eventually pulled the market lower as the can instead of being kicked down the road met a brick wall.
Source: StockCharts.com
So let us fast forward a bit to the present situation. The Fed made unprecedented moves with its first announced quantitative easing program (QE1) in March of 2009. What was the result? More than an 80% rally in the S&P 500 before the April 2010 highs. As the summer of 2010 approached it looked like we would at a minimum get a growth recession (positive economic growth but the growth rate falls considerably) and possibly a recession in the not too distant future. Bernanke in a Jackson Hole speech in August mentioned the possibility of another round of QE (QE2) and off went the markets. Since the August bottom the S&P 500 has rallied nearly 20%.
Source: StockCharts.com
What is the point of all of this discussion? During both the interest rate moves of 2006 and 2007 the market initially moved higher but subsequently corrected. After both the 2009 and 2010 QE programs the market moved higher. The key point is that one of the biggest market movers in the global market place is the US Federal Reserve Chairman’s decisions, hence the mantra “Don’t fight the fed.” What is key is watching the reaction of the markets to Fed action. The market’s reaction to Bernanke lowering interest rates in 2007 was a flop as markets barely rallied 6% before peaking. As long as Bernanke’s money printing programs are large enough and bold enough we are likely to see higher stock prices, but we should be on the lookout for getting less bang for each QE buck.
My best guess is that this will occur possibly next year as Bernanke’s QE programs are likely to depress the USD which will eventually lead to higher input inflation from rising commodity prices which are priced in USDs, and also higher interest rates as creditors look down the road at a mounting debt problem for the US government, with both higher interest rates and higher inflation denting the positive impact of Bernanke’s monetary actions. So far though his actions are working to inflate asset prices, mainly the stock market, as the S&P 500 is technically running strong. From here on out it will be important to monitor market breadth in terms of gauging the health of the markets advance. Fewer and fewer stocks participating in the rally would tend to indicate the bull market is getting tired and provide the first clue that the market is peaking and Bernanke’s efforts are weakening. One key tool to monitor ahead is new 52 week highs for the S&P 500 and NASDAQ. As long as new 52 week highs remain strong then we should expect higher stock prices. Market peaks are a process, not an event, with tops occurring over time. Strong breadth leading into the January and April 2010 peaks were what led me to argue against getting too bearish as highlighted in the articles below:
- 01/20/2010 – Market Tops are a Process, Not an Event
- 04/21/2010 – Breadth Supports Continuation of Bull Market, Though Risks Remain for a Correction in the Near Term
I’ll leave a discussion of market breadth for another commentary but suffice it to say breadth remains strong and from my vantage point I do not see a major market peak occurring in the here and now. Rather, I think another bear market is a mid 2011 story. But until then as long as breadth remains strong and as long as the markets react favorably to Bernanke’s QE programs, the trend remains up and fighting it will likely prove to be a frustrating task. Bears will eventually be proven right just as a broken clock is right twice a day. Investors saw great value during the tech bubble of the 1990s but missed out on spectacular returns in the final years closing out the decade. Conversely, the perma bulls got their heads handed to them as the tech bubble burst. The key is not just being right, but being right in a timely manner, and so the question of the day is: “Do you wanna be right, or do you wanna make money?”
