FYI | Jun 22 2006
Reader John Bedson sold his entire portfolio of equities immediately before the May 2006 correction. He is buying again while keeping 75% in cash for the time being. Here’s why.
John Bedson: "The spike in the price of gold was one of the reasons that I gave [to sell out of the market before the May correction], but now we have the opposite situation with a crash in the price of gold. To me this indicates that inflation is much less of a worry than it was and that the comparative value of cash has risen rapidly. It is my belief that the value of cash moves in direct inversion to the price of gold. The fact that the US yield curve has inverted at the short end but not at the long end also encourages me. It is inversion at the long end that predicts inflation and that has not happened. The prospect of inflation that is one of the real killers for shares and that problem does not seem significant to me any more.
There have been several significant happenings since 19th April 2006 and they are all interconnected:
1. The price of gold has crashed.
2. The emerging markets bubble has been violently burst.
3. Investors and hedge funds have awoken to the fact that central bank tightening is and will be more substantial than previously thought.
4. The "Carry Trade" has started to unwind.
5. Bernanke has spooked the markets by showing apparent incompetence in his communications.
6. US, Canadian, European and Australian shares are down by 10%-ish.
7. The Japanese Nikkei has fallen 20%.
8. Metal prices have fallen quite steeply and copper appears to have moved into capitulation mode.
9. The US has awoken to the fact that it is suffering and is likely to continue to suffer a rapid housing slowdown.
All of this means that globally we are entering a "credit squeeze." It means that we are late in the economic cycle and that substantial gains in equity prices are unlikely for the near future.
The US economic cycle goes more or less as follows and it has global impact:
Consumption increases – Commodity prices rise – Concerns over Inflation – Sales of US dollar – US dollar weakens – Purchases of Gold – Price of Gold rises rapidly – Rising commodity price lag impact on Core Inflation – Fed raises interest rates to counter Inflation – Purchases of US dollar – US dollar strengthens – Sales of Gold – Gold price falls – (*) High interest rates slow Property and Retail Sales (*) – Strong US dollar slows Exports – Earnings fall – All Markets fall – Consumption falls – Commodity and Energy prices fall – Falling Commodity and energy prices lag impact on Core Inflation – Fed lowers interest rates – Consumption slowly recovers – Company earnings rise – All Markets rise – Consumption increases – the next cycle begins.
We are at the point marked between (*) in the text above. So you can see why I am not too optimistic about shares right now. Nevertheless, as shares did not overshoot on the upside by much and as P/E levels are below historical averages, I cannot imagine that they will fall much more than we have already seen. But I could be wrong. We might see another 10%+ come off our shares, which is why I am only 25% invested now. 75% of my portfolio is in cash earning a good rate of return.
My feeling is that we will come out of this with an upward sloping sideways move with high volatility and then take a larger fall approximately in October 2006 with a fairly rapid recovery after that.
The 25% that I have invested is therefore a gamble on a "summer Rally" (US Summer) in the hope that I can make another profit before September 2006. I’ll add to my positions if the rally eventuates. The market action in the US on 21 June moved above critical technical resistance and the S&P500 bounced off its 200 day moving average. A similar thing happened this time last year and set the markets up for a summer rally. I’m therefore optimistic that the July/August rally could be underway. Historically, July is the forth best month of the year to own stocks and now could be the time to buy them.
But longer term I see further declines in both the US and Australian markets and in some ways I am playing a dangerous game. I think that we are in for a "double-dip" fall in the price of equities and I am trying to gain the uplift between the two dips. If I am wrong and equities fall another 10%-ish, my 25% invested position will suffer. If I’m wrong and equities make a substantial recovery, my 75% cash position will suffer, although I will add to my equity positions if this eventuates. If I’m more or less right, I’ll be able to sell at a profit either late August or September and hopefully sit out the October correction with 100% in cash, which is what I did with the May correction.
It’s not for me to advise anyone how to invest their money and risk their hard earned cash. I’m not paid to do that and I’m not a financial advisor. I’m a full time investor and I’m simply explaining how I see the financial world at the moment. You should read a wide sample of commentators and then follow a path that suits your circumstances and your psychology. Win or lose you have to be happy with what you are doing – but you’ll be happier if you win!"
John Bedson’s commentary and predictions on Australian stock market action are available subscription free at: http://www.australianinvestmentguide.com/