Be Prepared

As the market rallies cracks are beginning to show in the internals of the market. Arthur Cashin points out this week that the old saw that the public (weak hands) control the market in the morning and the pros take control in the afternoon may be a glaring admission of a tempering of risk by market pros. The strongest time of the day recently has been the first half hour of trading. The last hour has been a big loser. It appears market pros are lightening up in the last hour of trading.  Here is the data by way of Arthur and the Bespoke investment Group.

 A Study In Time – The nice folks over at Bespoke Investment Group have rummaged through their voluminous database to reveal that the market recently has developed two personalities – an opening one and a closing one.  Here, courtesy of The Kirk Report, is a bit of what they said:

 Had you bought the S&P 500 at the close and sold at 10 AM ET on the next trading day, you would be up 7.97% over the last six months. This is by far the best time of the day for the market. From 10 AM to 3 PM, the market has seen gains, but they have been minimal. Had you bought at 3 PM and sold at the close, however, you would be down 4.52%, which is a big loss in a market that is up 10% over the last six months. We’ve talked about the “Smart Money Indicator” in the past, which is a market axiom that says the “dumb money, ” or retail money, trades at the open while the “smart money,” or institutional money, trades at the close. If this is the case, the retail investor has been bidding this market higher, while the institutional money has been fighting it the entire way up. The fact that individual investor sentiment is hardly bullish would contradict this theory, however, but either way, it’s an interesting trend, and it’s one to keep in mind when you’re trading this market over the last two weeks of 2013.

Next year is Year II in the US Presidential Cycle. The second year of the US Presidential Cycle tends to be the weakest of the four years as monetary and fiscal policy begins to tighten. Year II of the cycle has shown a tendency to have a midyear setback to the market and then a rally to finish up on the year. Year III (which would be 2015) is the strongest year of the cycle.  Most market participants that I read and respect are predicting an up year for 2014 with between an 8-12% return and a midyear correction on the order of 10% or even 20%. Seasonality did not work so well in 2013 as the Federal Reserve’s QE policy dictated market direction. That policy is now looking to be wound down. How will that affect markets and seasonality? Will it be a return to form?

The bond market is a dangerous place to be in most investors minds. Our response has been to underweight our bond allocation as well as shorten duration to the 5-7 year range in order to account for the risk of rising interest rates. We have a chart here from Citigroup Foreign Exchange Technicals group that shows, counter intuitively, that Quantitative Easing leads to higher rates during QE and that the end of QE brings lower rates on the US Treasury 10 year. Citi’s thesis is that more QE leads to a rush into higher risk assets and the dumping of bonds to the government as the buyer. The end of QE brings money back into safer assets like the US 10 year as it flows out of stocks and hot money destinations like emerging markets. Keep an eye on the 10 year and emerging markets like Turkey and Malaysia.


The market was relieved this week to have the Federal Reserve start to remove the band aid that is QE. 2014 is going to be a very interesting year (as they all seem to be lately).  We are cautious as everyone seems to be buying stocks and selling bonds. The contrarian in us continues to question the moves of the broader investing public. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful. – Warren Buffett

The winding down of QE could bring some bumps in the road. While we look for rates to go higher in time the end of QE may force rates lower, ironically, as investors come back to less risky assets. The market is reaching all time highs with all time high profit margins. Something else to watch out for in 2014 is a reversion to the mean in profit margins which could lead to sky high valuations in the stock market. We question whether QE has led corporate executives, whose pay is directly tied to stock performance, to manage even more to what Wall Street’s expectations. Get more out of less. Borrow to pay higher dividends and buy back stock. Do not invest in plants, equipment, and technology and hire more workers. Could allowing the stock market to fall give executives the excuse to invest more in plants and workers? Thereby improving the economy. I have always surmised that the ending of QE would be far more difficult than beginning it. The handoff could easily cause some major bumps in the road. We do believe that this bull is long in the tooth and has surpassed the average age of a bull market. The slow winding down of QE may allow for further gains in the market but valuations are stretched. The sideways move in the market that is going on 14 years now has produced a major consolidation period much akin to the 1966-82 period. Most consolidation phases consist of 3 major selloffs. We have had two and are due for a third. If those bumps in the road come due to recession or QE handoff this may produce one of the great buying opportunities of our generation.

Our companies are the most financially prepared and most productively operated they have been at any time during the nearly four decades since I graduated from business school. – Richard Fisher of the Dallas Fed on  12/9/13.

The above quote is from Dallas Fed Governor (and voting member in 2014) Richard Fisher who has long advocated that the current policy of QE is having dangerous unintended effects and diminishing benefits. I keep reading the quote and find myself stuck on one word. The word is prepared. Prepared for what Governor? I surmise that they are prepared, in his mind, for an end to the emergency policies of the Federal Reserve and the inevitable bumps in the road associated with an end to those policies. Be prepared.

The turn in the calendar in 2014 may entice managers to raise cash levels early on in the year as to not suffer any outsized losses at the start of 2014. A large loss early in 2014 would make for a tough slog all year. However, missing out on some upside early on in the New Year would be far easier to make up for on the performance side. Always keep an eye on the calendar. Seminal changes tend to take place at the turn of the year.

Happy Holidays and Merry Christmas!!

To learn more about us and Blackthorn Asset Management LLC visit our website at .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

I learned that courage was not the absence of fear, but the triumph over it. The brave man is not he who does not feel afraid, but he who conquers that fear. – Nelson Mandela

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Published in: on December 21, 2013 at 9:19 am  Leave a Comment  
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