Nothing Learned

A couple of weeks ago, MarketWatch featured a story titled “Don’t Just Do Something; Sit There.” Here are some highlights:

You learn in grade school that a correction fixes something that is wrong.

That’s why “correction” is such a difficult term when it comes to the stock market and investing, because the market is said to be in a correction when it is moving backwards after a big advance. But if the market is “correct” when it goes down, then it must have been “incorrect” when it was on the rise, and no investor likes that idea.

Confused? Well, stock market corrections have that effect on people.

Right now, judging from emails and message boards and letters I get from ordinary investors, there’s a real fear that what’s happening now is no mere correction, but the first step back toward the abyss, another leg down, the dreaded “double-dip recession” and more.

While I don’t know many investment pros who read the tea leaves that way, it’s important to know what to look at and think about if current conditions make you nervous and you suddenly believe that what is “correct” is to give up on what has been working.

Excuse me for asking, but what has been working? Most investors have been faced with a lost decade of buying and holding and are still reeling from the meltdown of 2008. It’s about time that people finally wake up and question old paradigms.

“Corrections are rogue; you don’t know where they are going to wind up and how long they will go on for, and that’s a big reason why they are scary,” said Walter S. Frank, chief investment officer for Moneyletter. “I don’t see what we’re going through right now as a reason to change allocations, but it’s hard for a lot of people to just stand still when they get scared.”

Famous last words! After two devastating bear markets in 10 years, a current rally based on smoke and mirrors, and this chief investment officer does not see a reason for changing allocations. That would be acceptable as long as an exit strategy exists to avoid a repeat disaster, but that is probably a foreign word to Walter Frank.

Indeed, when it comes to making portfolio changes, the underlying reasons to make a move typically can be linked to one or more of three root causes:

1) The market has changed.

2) The investment has changed.

3) You, the investor, have changed.

Most observers will tell you that market changes are the least important reason to make a move, but they are the one most investors react to. This is how an investor can have a financial plan, throw it away when the market takes a dive, and then miss out on the recovery.

Missing out on a recovery? Has it ever occurred to this writer that if you don’t participate in a downturn in the first place, you don’t need to recover? I have made this point numerous times after the meltdown of 2008. As of this writing, the S&P; 500 still needs to rise almost 20% to get to the level of our sell signal effective 6/23/08.

Everything is in place to make the current correction a short one. Corporate earnings may not be great, but they were so bad at the end of 2008 that the fourth-quarter numbers from 2009 only have to hurdle a low bar.

“I don’t know that things have gone down to turn this into a buying opportunity, and I won’t be surprised if things go down further before they look better,” said Frank. “But I know I wouldn’t be too worried about a correction when it happens in a bull market that looks like it will continue for awhile.”

Sure, corrections happen all the time; the problem is that you can never be sure whether they turn into something worse, like a move back into bear territory. Given what has happened in the market in 2008 along with a stock market recovery in 2009, odds are increasingly high that the downside will come into play again.

Unlike the recovery in 2003, economic fundamentals are horrible, debt on all levels is unsustainable and unemployment, a lagging indicator, shows no signs of improvement. Actually, unemployment will get worse as states, cities and municipalities struggle with budget shortfalls. Those potential layoffs have not been factored in current unemployment figures.

Be that as it may, the market could very well ignore all bad news and continue to climb a wall of worry. If it does, we will follow the trend until the end when it bends and stops us out of our positions.

To me, not having any exit strategy at all is asking for trouble and simply confirms that nothing was learned from the past.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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