The Sun Will Come Out … Tomorrow …

By Prieur du Plessis, on August 5th, 2008 posted in: Guest Bloggers

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This post is a guest contribution by Bennet Sedacca*, President of Atlantic Advisors Asset Management.

The sun will come out tomorrow, bet your bottom dollar, that tomorrow, there’ll be Sun! Just thinkin’ about tomorrow clears away the cobwebs and the sorrow ‘til there’s none!!!!! – From the Broadway Show, Annie.

Let me be blunt; the world is mired in a secular bear market in stocks.

1. The Credit Crisis that we have been expecting is here.
2. Inflation in the things that we need is on the rise.
3. Unemployment rates are on the increase.
4. We are at war on many fronts.
5. Social acrimony is beginning to build.
6. Federal authorities from the Treasury Department to the Federal Reserve to the European Central Bank to the Securities and Exchange Commission intervene in our markets daily, making our lives as professional money managers more difficult that they should be under truly “free” markets.
7. Real-estate prices are plummeting.
8. Credit is available only for a few very healthy companies and those that the Fed feels are important enough to bail out while the rest of us have to pay for our mistakes.

So, are you ready to walk to your nearest ledge yet?

The economy and the credit/equity markets are anything but a walk in the park these days. But hey, this game is not for amateurs and this cycle will most certainly separate those that a) understand the big picture, b) know how to measure risk and c) know how to preserve capital. Why? Because the sun WILL come out tomorrow.

Tomorrow in this case may be a bit far off, but it is out there, and the goal is to make it all the way to tomorrow with your capital intact and hopefully with some gains along the way.

The difference between realists and “perma-bears” (I consider myself a realist) is that “perma-bears” wake up praying for rain and don’t like to plan for tomorrow. Realists, on the other hand, look to get through the rainy days and then pounce when the sun is about to peek out again.

How far away is “tomorrow”?
Ah yes, the $64 billion question. Over the last few years I have written a few different versions of the roadmap that I expect the financial markets to follow and no matter what methodology I use, I keep coming up with a “tomorrow” in mid to late 2010 for equities. This does not mean, of course, that money cannot be made between now and “tomorrow” – it just means that high-quality fixed-income securities, low-beta investing and a hedged technique are the order of the day. Folks are starting to figure out that traditional “long-only investing” means that you have to be invested for a long time. I have no problem with that philosophy as long as your time horizon is 100 years and that you don’t mind 15- to 17-year periods in between when you don’t make any money, like the one we are in now. I have to be frank and say that I have yet to meet an investor with a 100-year time horizon and the patience to sit through a secular bear market in stocks and the volatility that goes with it.

Why 2010 for “tomorrow”?
I am a big believer in cycles. The greatest cycle of them all, and the one that in my opinion influences markets the most, is the Presidential Cycle. For those not familiar with the cycle, it goes like this:

1. What every first-term President wants is a second term.
2. What every second-term President wants is: a) a great legacy and b) his party to remain in office.

The numbers speak for themselves in this respect as stock prices and Presidential approval ratings are nearly 100% correlated. (This makes sense as folks that are making money in their portfolios are much happier than those that are watching their portfolio values dwindle daily.)

According to a study done by Pepperdine University, if you had invested $1,000 in the Dow Jones Industrial Average every election cycle on January 1 of the first year of every Presidential term and sold on October 15th of the second year since 1950, your $1,000 would today be worth approximately $650 – not inflation adjusted. On the other hand, had you invested $1,000 on October 15th of the second year of every term and sold on December 31st of the last year of every Presidential term since 1950, your $1,000 would now be worth more than $70,000. Can this be a coincidence? I think not.

History shows us that fiscal and/or monetary stimulus shows up in the third and fourth year of terms, which in turn NORMALLY helps the economy and markets. The election comes, folks feel all warm and fuzzy, and then vote for the incumbent. At least this is supposed to be the way it works. But, alas, this time is truly different.

We have seen every kind of stimulus known to man (and I am sure many still await additional stimulus from regulators before tomorrow comes) and yet the real economy and markets have not responded. It is like being a doctor calling for the crash cart and applying emergency technique available but eventually the doctor just has to pull the covers over the patient. I really do not like using that analogy at present as our family unexpectedly lost our 8-year-old Lab, Luke, last week, but it is the one that I think is the most appropiate. The patient, in this case, is the US and global economy, which are not responding to stimulus.

If I had told you a year ago that we would have the Fed back-stopping the JPM/Bear Stearns deal, the Fed creating all sorts of ridiculous term lending facilities, money supply growing at alarming rates and Fed funds falling from 5½% to 2%, you would think that the economy, credit and equity markets would be roaring, right?

They are roaring, but in the wrong direction. So once the election (which ought to be a delightful mud-slinging affair) is over, no matter who is victorious, the stimuli we have witnessed may very well be removed. And if the economy and markets haven’t responded to this latest round of record stimulus, just take a guess how they will do without it. Just imagine a cardiac ward without a crash cart and I think you will get the picture.

There are other reasons to expect a 2010 low as well. Secular bear markets tend to last 16 years or so, which for new folks in the business will feel like an eternity. The preceding secular bull market lasted 18 years from 1982 – 2000 and was the giddiest secular bull market of them all. With that incredible run now well behind us, we suggest that this current secular bear market will take the biggest toll as we recover from the last party-induced hangover of 1982 – 2000.

It is okay by us as we are positioned in a risk-averse fashion with tight risk controls firmly in place. In the midst of these long-term secular moves come shorter-term cyclical moves that last 3 to 4 years. Consider that the secular bear started in 2000 (at the height of the “dot-com” era) and began with a 3-year, gut wrenching, 50% cyclical bear move into 2003, which in turn led to a 4-year, 100% move back to the 2000 highs by 2007.

It’s funny how arithmetic works. If you had simply stayed invested the whole time from 2000 – 2007 you would have nothing to show for it except a lot of aggravation and used up “emotional capital”. I firmly believe that a vicious cyclical bear (within the context of an ongoing secular bear) began in July 2007 and will last the typical 3 – 4 years and bottom in mid- to late 2010, with a target of a mind-numbing S&P 500 target of 700 – 900 or so.

I realize this all sounds terribly bearish, but flip it around and what we are really facing is an exciting, opportunistic period for those that understand the big picture and are willing to adapt to the world around us.

What if I told you that I thought a 2010 low in the 700 – 900 range would be one of the best buying opportunities you will see for quite some time? For those that have been “long only” since 2000, it would be just another rally back to my break-even point from 2000. But I fully expect this secular bear to end 15 – 18 years after 2000 at around the same levels of the 2000 high in the S&P 500 in the 1500 – 1600 range, which would be quite a nice move from 800, no?

This is why we must admit where we are, do not hide from it, work twice as hard as our competition and be ready for almost everything in between.

What can happen between today and “tomorrow”?
ANYTHING. The Federal Reserve, ECB, etc., have pulled out nearly every stop to help the dying patient, which is our economy and markets. I wake up every morning wondering what intervention I will face. I made the comment today that “if you would have given me this Tuesday’s newspaper on Monday night, I would have lost money on Tuesday”. Trust me that I am NOT proud of that statement but the markets have taken on a bit of a random, surreal tone of late as the authorities intervene in their vain attempt to attack short-sellers or as we like to say, “Get Shorty”.

The problem with “getting Shorty” is that the shorts are a source of demand as they eventually need to buy back their shares sold short. So while the SEC and friends have lots of fun squeezing folks while changing the rules on shorting Fannie Mae, Freddie Mac and 17 other important entities, they are rather myopic. No matter how much intervention, markets and stocks eventually find the correct level. I suppose you can slow it down but eventually, if companies are mismanaged and act with incredible hubris, they will eventually fail or be merged into a stronger and well-managed entity as we fully expect will happen by 2010 in the financial space.

What other surprises could lie on the horizon for investors as the authorities attempt to prop up markets? I have the distinct privilege of knowing and interacting with some of the best minds on Wall Street. Everyone seems to be “playing close to the vest” as we have no idea what we will wake up to tomorrow morning. Will short selling be changed backed to the “up-tick rule” where stocks can only be shorted on a plus tick? Will short selling be outlawed? Will FAS 157 be revoked? Will the Federal Reserve become federal and not privately owned by member banks? Will margin requirements be loosened? Will the Treasury tell us they will buy S&P futures every day to support the markets? Will Sovereign Wealth Funds be allowed to gobble up all of our ailing investment banks and regional banks? I could go on and on …

The key takeaway is that any and all of the aforementioned band-aids are indeed possible, but a tourniquet is needed for this patient. The party went on for too long and, like they say, “payback is hell”.

Summary – How to be positioned for “tomorrow”
I believe the correct posture is one of caution, not to be confused with being bearish. I believe that every bet one makes must be measured and have considerable thought behind it. It is truly okay to miss opportunities, but the big cyclical moves, even within secular bear markets, must be had. The same is true for cyclical bear moves within secular bull markets, which I believe could be a result of a combination of both time and price. Time could take us to 2014 – 2018, and price could take us back to the 1500 – 1600 area in the S&P 500 over the next decade or so with lots of opportunity in between.

One thing I feel is true is that long-only investing and blindly trusting the authorities, governing bodies and even many financial advisors that don’t understand and can’t articulate the “big picture”, could be a problem. I say all of this with respect to others in our profession, but this is not a market for newbies. In a nutshell, there is no substitute for experience and gray hair.

I do believe one thing for sure. The sun will definitely come out tomorrow. I just have to be around with my capital and my investors’ capital to take advantage of the sunshine.

One last note, and then I welcome feedback. I have been speaking with my son lately about our industry and what classes to take as he is a rising junior in college and has aspirations in our industry in some capacity. Without further ado, below is “Bennet’s Curriculum” for rising money managers and traders:

1. Macro-economics. The big picture is key.
2. History. Investors make the same mistakes over and over again.
3. Accounting. Know how to read a balance sheet. Don’t rely on analysts.
4. Sociology. Learn “behavioralism”. It’s not about being right, it’s about making money.
5. Psychology. Fear and Greed rule. Always and forevermore.
6. Mathematics. This is not a game for children.

The rest, as they say, is history.

*President of Atlantic Advisors Asset Management, Bennet Sedacca brings with him more than 26 years of securities industry experience. From 1981 to 1997 he worked for several major investment banks, specializing in high-grade fixed-income securities marketing, trading and portfolio management. While working for PaineWebber as a Senior Vice- president, Bennet was a member of the Chairman’s Council for four consecutive years. During his years with Salomon Smith Barney as a Vice-president, he established an institutional fixed income presence in Central Florida.

In 1997, Bennet formed Sedacca Capital Management focusing on portfolio management for high-net worth individuals and small to mid-sized institutions. He is also a contributor to the financial website, www.minyanville.com and is regularly quoted in Wall Street Journal Online, Barron’s and Bloomberg.

Bennet graduated from Rutgers University in 1982 with a degree in Economics and was a member of the International Honor Society of Economics.

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