If you substitute the word enemy with markets the theory becomes applicable to developing investment strategies. Especially now.
When I give you my outlook and strategy I take them from an array of possible scenarios and possible strategies. What I discuss in each letter is the most likely one.
Early in 2001 I predicted a strong rebound by the end of 2001 or early part of 2002. The odds were quite high due to the huge injection of liquidity by the Fed. The strategy I recommended was to invest in value and commodity driven stocks. I also suggested avoiding bonds.
As I mentioned a few times, however, I feel that this ninth financial cycle (since 1960) is going to be different, with lead-lags between monetary aggregates and business activity much shorter than the usual 12-18 months.
I am beginning to consider a low probability scenario that could eventually influence our investment strategy. This scenario is based on the fact that the economy, after an initial strong rebound (which we are experiencing), is going to slow down again very soon. Possibly toward the end of the year.
Growth in monetary aggregates peaked last December and has been declining for four months. This development is beginning to have some significance and I need to start taking it into account. The slow rebound in retail sales and car sales, down tick in consumer confidence and in the ISM non-manufacturing index are minor developments, but they could be the beginning of a new trend. What are the odds? 10%. They are not significant enough to make changes in strategy, but should be followed closely.
An important lesson I learned is that economic and financial adjustments happen very slowly. The important step is to take notice of the change and follow it closely. In a game of strategy one must keep track of various playable options and gradually shift to more profitable strategies as the game slowly evolves.
The financial markets are fast approaching the important summer months. This is an important seasonal period when stocks are likely to do poorly and bonds act well. During these months commodities also tend to move in a narrow range. The seasonality of these markets is too reliable to be ignored. I believe it is wise to adapt to it.
What to do?
• I am becoming neutral-to-bullish on bonds, but just for the summer months. They will become a good alternative to cash.
• The age of high PE and no dividend stocks has been over for more than a year. I am expecting this trend to continue.
• Emphasize low PE and dividend paying companies. Ideally yields should be greater than 2-3%.
• Commodity driven stocks remain attractive because of the exaggerated-market-distorting easing policy of the Fed. They may stabilize in the summer months.
• Reducing unprofitable positions and re-investing in the strongest ones is always a valid strategy.
(This note appeared in the 4/22/02 issue of The Peter dag Portfolio)
George Dagnino, PhD
Editor, The Peter Dag Portfolio. Since 1977
2009 Market Timer of the Year by Timer Digest
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