What a Rally!

For those invested in the stock market, Wednesday was a great day. The Dow rose over 250 points. The rest of the week wasn’t bad either.

Before you begin to sing “Happy Days are Here Again,” and bet the ranch on either an economic recovery or a stock market rally, take a look at the little squiggle that was worth over 250 points on the Dow.

The only thing impressive about it was that a blip barely visible could cause such a major reaction. Not something to feel real comfortable about! David Rosenberg is even dubious regarding the validity of the number, providing nine reasons to doubt it.

Don Worden, respected and seasoned stock market analyst, put things into additional perspective in his daily blurb on TC2000 (subscription service, no link):

… it is true that +254.75 is a sizeable one-day advance that could be the start of something big. But it ain’t necessarily so. As a matter of fact, we had a bigger advance (+3.32%) less than two months ago on 7/7/10. And we’ve had a number of comparable advances since then. But all it resulted in was the August high, which was only a month following the big (+3.32%) advance of early July.

The stock market is a game that is increasingly influenced by Fed actions, high-speed and high-volume traders, possible interventions by the Plunge Protection Team and politics. Its backdrop is a hollowed out economy, an insolvent government, massive unemployment and increasing bankruptcies for businesses and individuals. All of these negative factors exist despite the largest stimulus in history. Unfortunately, despite the Washington and media pollyannas, there is little evidence that the bottom has been reached.

In my opinion, we are sitting on a powder keg that is going to blow.  Few people should have more than 30% of their investable assets in conventional stocks or bonds. My portfolio is substantially less than that. We are are going to have some major surprises soon. Whether the explosions produce a stock market dropping of 5,000 or 15,000 is unknown. Short of inflation developing quickly, I look for something moving toward the lower level.

If the stock market goes to 15,000, it will be driven by dramatic inflation. In that case, it is likely to be worth less than its current level, at least in purchasing power. Stocks can be an inflation hedge, albeit an imperfect one. In an inflationary scenario they beat holding cash, but generally do not fully keep up with inflation. One can see that in our last inflationary battle during the late 1970s. Inflation went into double digits and stocks went down.

No one can predict markets, especially in the short-term. It is my belief that in the long-term we will have horrendous inflation. I have written elsewhere why this is probable. It need not be, but politicians likely will create it.

Long-term investors must be careful. These markets are for speculation. Money will be made if you are on the right side of the market at the right time. Lots will be lost if you are not. You pays your money, you takes your chances. But there is no reason to be play this game unless you are gambling. It is a fool’s game. The economics are terrible. The politics worse.

I am a believer that solid companies will survive almost anything. I am not a believer that they will not get crushed if a market crash. They will recover, eventually. Bear markets typically end with Price Earnings ratios in the 6 – 8 range. That includes the bluest of Blue Chips. Look at your holdings and see what would happen if PEs dropped to that level. Of course good companies will come back. They always do. But be aware of the fact that the time period can be long. For example, the Dow didn’t return to its 1929 levels until 1954, a full 25 years later!  The Dow first touched 1000 in 1966, dropping to 750 by the end of that year. By early 1970 it had dropped below 650. It was 1982 before it exceeded the 1000 level and remained above it.

For short-term speculators, markets are apt to go up for a while. It is in the interests of the Administration and incumbents to have that happen before the election. What you saw Wednesday might have been a recognition of that fact. Or, maybe it was the Administration attempting to “pump” markets. Or maybe it was just “animal instincts.”

A reasonable goal for investors, it seems to me, is to recognize the enormous risks in play and avoid most of them. If you can get through the next two years with your purchasing power intact, you likely will rank in the top 5% of investors. That goal might be achievable with a nominal net worth increase or decrease. It depends upon the inflation/deflation mix. Your focus should be on retention of purchasing power.

I favor gold or other hard investments that tend to hold their purchasing power. I think that might enable me to be in the top 5%. Actually it might even enable outperformance if you believe gold has not yet become a bubble (I believe it has not). At some point, it is likely to go parabolic when the public crowds in. I don’t believe we are near that point yet.

I also do some speculation, but only with funds that I can afford to lose.

Conditions are volatile. There is no strategy that fits everyone. Nor is it likely that the proper strategy for you will be proper over a 2 – 3 year period. These are not your father’s markets. These are historical times, seen only once or less per century.

This post originally appeared on 20smoney

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