I went tactically long of equities at the end of last week, expecting a sharp bear rally, and Monday's one day move, particularly in Japan (up 14%) and the US (up 11%) was what I might have reasonably expected for this whole week, so I've booked some profits. We're in a period of what veteran investor Barton Biggs has termed 'condensed lunacy'. The speed and scale of moves across asset markets are stunning, and in stocks we have seen nothing like this volatility since the huge swings during the 1929-33 Great Crash. This hasn't been a 'buy and hold' market for a very long time, as evidenced by the appalling returns generated by mutual funds over the last decade. So stepping back from the gut wrenching volatility, what's the big picture? We're still in a huge bear cycle for US equities. I wrote on 24 July that 'we're now probably midway through a structural cycle that may last to 2015 or so. Another way of looking at it is that returns were 'front loaded' during the huge bull market from 1983 to 2000, making the entry point crucial for successful investing'. Indeed, I'd expect the 2002 lows to be tested in the next few months, although with the immediate threat of financial meltdown averted, this rally may get us into the New Year, albeit in choppy fashion. Last Friday looked like an important interim low, although it may be tested. Even in long term bear markets, big rallies lasting weeks and even months are common, and a wise investor will make the most of them and then cash out and sit on the sidelines. It's buy and fold, not buy and hold. Away from the banking mess, it is notable that big mining groups like Rio are now warning of a slowdown in Chinese demand; I warned as long ago as last Spring that China would stumble as their growth model was simply unsustainable. As US consumers retrench dramatically, we now need Chinese and other Asian consumers to take up some of the slack to sustain global growth. Alternatively, China needs to use its huge holdings of US Treasuries held at the Fed to help support the US economy eg by swapping them for MBS and other securities to inject liquidity into financial markets. Otherwise, China will become part of the problem, not the solution. Iran has also fallen off the market's radar screen; back in July, there was probably $25-30 of geopolitical risk premium in the oil price related to Iran/Nigeria, now there's zilch. I correctly identified the investment bubble in oil a few months back and was a seller against the overwhelmingly bullish consensus; now I'm going long crude call options. My target was always $60-80 (see Oil: We hit that tipping point on 4 June), or the marginal production cost of the most expensive conventional offshore production and oil sands. We may well undershoot, but not for long I suspect. Aside from potential OPEC action in November and beyond, and the rapid shelving of many high cost production schemes curtailing medium term supply, the possibility of an Israeli strike on Iran is rising again and stands at probably 30% plus. Despite US diplomatic overtures, it seems that Iran has seen the current US economic chaos as an opportunity to go for nuclear broke, and Russia in its newly aggressive mood, is assisting both with the reactor and advanced surface to air missile systems. Politically, an attack before the January inauguration of Obama (and let's face it, the McCain campaign has imploded after stirring up the lunatic fringe of the Republican party) is a window of opportunity unlikely to open again before Iran achieves nuclear status. Neighbouring Sunni Arab states like Saudi would quietly applaud a successful operation, whatever they say officially. It still seems like a wild gamble, but Israel has performed a few of those before and won; national self-preservation is paramount. This has been a year full of historic surprises, and it's not over yet.
Posts
