Jan 17, 2014 ... Gerald Loeb wrote in The Battle for Investment Survival that markets do not go up
forever. His experience, writing in the wake of the Great ...
January 17, 2014 Fourth Quarter 2013 In the 90’s, investors experienced markets that advanced year after year. The mantra was buy on the dips. The market meltdown of 1987 was all but forgotten. This combination of overconfidence and forgetfulness was quickly corrected by the market meltdown that began in March 2000. There were short rallies from time to time but no durable advances until March 9, 2003. By this time the news was horrible and few believed the market would ever rally again. But it did, as it always does when most don’t expect it. Then came the drop in 2007-08 in the wake of the mortgage crisis. The list of negative events in the past thirteen years includes a terrorist attack on our homeland, wars in Iraq and Afghanistan, the mortgage crisis, widely-publicized and bitterly-contested budget battles and threats of a government shutdown. And this is a short list. Who would have imagined with that kind of backdrop that 2013 would be one of the best market years ever? Both the S&P 500 and the Dow reached all-time highs, 1849.44 and 16588.25 respectively. The NASDAQ reached a thirteen-year high of 4177.73. It is noteworthy that the highs were reached on December 31, 2013. The old NASDAQ high was 5132.52 reached in March 2000. In response to the repeated new highs, the naysayers continuously questioned the sustainability of the market advance. The term “bubble” was heard constantly. The Fed’s easy money stance buttressed the bear’s viewpoint. One additional more objective data point was the high distribution day count: there were six days of recent institutional selling in the five weeks that ended the year. Not all were unequivocal selling days, but the count remained high through the end of the year. Throughout the year, as distribution days piled up, the market rallied, blunting the effect of these heavy selling days. For instance, the distribution day count just before Thanksgiving was six also for the 500 and NASDAQ, yet both rallied into the end of the year eclipsing resistance levels of 4000 on the NASDAQ and 1800 on the S&P 500. After years of difficult markets, it’s little wonder that observers would doubt a nascent rally. People came to believe that the 1990’s market was the norm when in fact it was an aberration. In 1935, Gerald Loeb wrote in The Battle for Investment Survival that markets do not go up forever. His experience, writing in the wake of the Great Crash of 1929, was that one must be ever mindful of the market condition and on guard against market reversals, both up and down. Loeb observed that the market was dominated by “Buy-and-Holders,” just before the Crash. Writing in the 1995 Foreword to Loeb’s book, John Rothchild notes, “The ranks of the Buyers-and-Holders have swelled to the point that nearly the entire population is Buying and Holding.” However, the market, with some interruptions, continued upward until 2000 so timing the selloff was difficult. Loeb, in his book, describes in detail how a prolonged bear market affects the psyche and modus operandi of investors. When it comes to market memory, the bad times are remembered more vividly and for a longer time than the good. By definition, a market making new highs is a bull market. New highs abound not only in the indexes, but among an ever-increasing number of individual names, that is, more than 500 New High’s show up regularly on a daily basis. The problem is that for thirteen years investors’ attitudes have been conditioned by difficult and variable markets and backdrop. Investors have become skeptical of bull market moves, doubting that they can last. Money manager, Jim Cullen, refers to current conditions as a “Melt-up Market,” by which he means “one that moves up for 500 days without a 10% correction.” Lest one think that things are too “bubblelicious,” consider that the longest period without a correction of 10% or more was 1990-97. The number of days was 1767.
There are seven other periods of 500 days or more without a correction of 10%. Only one, 1953-55 (510 days) was shorter than the count at Thanksgiving, i.e. the current condition, then 543 days. Cullen additionally points out that “one of the most powerful long term drivers of stock prices is a massive…shift from bonds and cash into stocks after stocks reach record low levels of ownership.” I might add that this shift in attitude can and does take some time, i.e. years, to play out. According to Cullen, previous record low levels of stock ownership were in the 50’s, early 80’s, early 1990 and 2008. The upward movements that took place after those record lows were dramatic, i.e., 1952-67, +330% and 1980-2000, +1260%. Cullen concludes that markets are “a long way from these extremes” of household ownership of stocks reached in 1966-67, 1970 and 2000. He concludes by saying that “melt-up markets can last a surprisingly long time….” The best time to be in the market is when the market is in an uptrend and stocks with superior fundamentals are in the lead. It is impossible to know if the current market will advance 1767 days before a 10% correction occurs or if 560 or so sessions, the current count, without a correction is sufficient to lead to a meaningful decline of 3%, 5% or more. The only way to prepare for what the market offers is to watch its price and volume action on a daily basis. The market’s future direction is detected in its daily price and volume behavior. One thing is clear from the experience of 2013: it was a good time to be fully invested. The current market rise started with the follow-through day on December 18, 2012. Shortly thereafter leading stocks broke out of price consolidations and continued higher. Since that time, not only have the indexes had their best year in recent memory, but the strongest and best performing stocks have stellar fundamentals. These market leaders include internet and biotech names. What is common to all these stocks is that they are innovators, constantly bringing forth new products and services that address new markets or previously unmet needs. When will this rally end or be interrupted by a correction? It is impossible to predict in advance, but generally bad markets return when no one expects it. As ever, I will be watching for action that jeopardizes the current uptrend or threatens the profits achieved. I would like to conclude by wishing you and your families a happy and prosperous 2014. John T. Preston Senior Vice President Beech Hill Advisors