How now October

Perm-bulls have had quite a party the past few months. You can always tell the bulls that lost a ton in the bear market to March as they are the people most bragging about “gains” they have now “made” year to date. The fact that most are still suffering heavy negative return numbers over the past 1, 3, 5 and in some cases even 10 years is not a point most care to acknowledge. And now we have October. Hopefully something will crack one way or another this month: either through a bullish pick up in buying volume (at last), or by a bearish pick up in sellers. Prices and valuations are high here; very tough to defend on rational arguments unless we are going to see a strong rebound in consumption and earnings over the next six months.
October doesn't have to be a negative month of course. Momentum driven markets, even on low volume and wide-eyed hope, can go on longer than logical. We know that so far 2009 has been the steepest rebound on the lowest volume ever since 1930. This is quite an achievement. But it doesn't exactly give capital-careful investors a warm content feeling about the price risk at present levels.
We can see from market history that October has been a particularly volatile month in secular bear periods and particularly so when the previous months have seen a strong summer rally as we did this year.
If I got to chose, I would have October be the last downside test to the 2007-2009 cyclical bear market. We had suspected from the outset that this bear market might last a couple of years; this month would be the 2nd anniversary.
The best plan for thinking investors is never confident predictions or one-sided plans but rather a plan A, B and C:
A. What if the market rolls over 10-20% here?
B. What if it moves lower than that?
C. What if it doesn't pull-back but continues to climb?
Failing to plan for different outcomes is no plan at all.
Define your rule set now, so that you will know what to do no matter what way this goes.

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4 Responses to How now October

  1. Anonymous says:

    I think you are right. Hope is not a strategy.
    The market correctly seen the end of recession 6 months ahead.
    So far the seasonality pattern is broken for this year.
    I'm pretty sure there will be a very strong pick up in economic activity over the next couple of months, therefore the nice earnings rebound is baked in the cake.
    Second dip for this year? Highly unlikely.
    Possibly the market sees this too in advance.
    Since nothing happened in September, I'm counting so much on the October or maybe early November correction, that I have the same paralyzing feeling: what if your plan C comes into play?
    I believe more and more that we will not see any meaningful correction this year, because too many of us anticipate it.
    The only thing I'm not sure about is how strong and steady the expansion will be, but that's another story.
    Oh, by the way:
    I was listening to Barclay's Capital the other day. Apparently they too follow ECRI, and their strategy is based on the Institution's prognosis.

  2. Anonymous says:

    Danielle, perhaps you can illustrate your strategy response for each of these cases? At what point do you recognize which way we are going and commit yourself? Personally, I find myself undecided for far too long and paralysis of action sets in. It becomes a losing game of psychological second guessing. By the time you finally convince yourself of the direction, it is usually too late.

  3. Anonymous says:

    I wish I could give you a simple answer to this question; it is complicated.
    Basically, you need to have maximum equity allocation rule at all times, i.e. 40, 50, 60%, as well as max position and sector rule defined in advance, i.e., no more than 5, 10 15 or 20% in anyone holding or sector.
    Then you need to set sell and buy rules defined in advance, i.e., technical trend count rules for when you will buy or sell a position. You may chose to only enter in tranches, i.e., buy 1/3 on a daily, then 1/3 on a weekly and the last 1/3 of your target on a monthly confirm of your rule set. Then you need to define your sell rule based on max pain you are comfortable with, i.e., if the position drops 5-10% I will sell and wait for a buy to be confirmed again on my rule set before re-entering or adding the next tranche.
    Never dollar cost average down if a price trend is still dropping. If your annual return target is 10% and a holding gives you a few years of returns in a matter of months, take your profit and reallocate the excess gains back over to fixed income etc. It’s a bit like weeding your garden; it takes some frequent care and pruning to keep your portfolio on track. If you don’t keep up the discipline and start falling back on hope or greed or fear, then you should just avoid risk assets altogether. We just aren't in a Rip Van Winkle environment.

  4. Anonymous says:

    Thanks again for the prompt and detailed response. How did you know that I was asleep at the keyboard? Unfortunately the garden has now been cleaned out and the green shoots are frozen. My main failing is that I allow macro fundementals to rigidify my stance to the point of ignoring momentum shifts. Then my stubborness kicks in and I refuse to shift my position. I will try to follow your guidelines.

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