Asymmetry


The markets continue to exhibit volatility that hasn’t been regularly present in a few years. While markets are not as volatile as 2011 yet, the end of QE in the U.S. and economic challenges around the globe signal that the easy to ride Fed reflation is over. 

Algorithmically, we see clear signs that the market is in a topping process. This process has been going on since early summer of 2014 and is becoming more likely to indicate that we are seeing a major top being put in. There is also a possibility that we get a parabolic move upward if we see very positive economic news, further Fed stimulus or investor irrationality if their fear of missing the upside suddenly outweighs their fear of losing money on the downside. 

Regardless of whether a final parabolic move upward in markets occurs or a new bear market begins sometime this year, we should be able to selectively navigate whichever occurs. Currently, we are cautiously buying some of the oversold assets in the market (rare as they are now) and simultaneously selling certain assets which have become overbought and lost their positive price momentum. 

I have been very cautious with new investor money as there are few low risk opportunities right now. Our asset allocation is currently 25% to 50% of investible assets, i.e. 401(k) or IRA balances, in cash or money markets, depending on client risk tolerance and time horizon. This is the way that I break down client accounts from most aggressive to least aggressive:

  • Moderate/Aggressive with more than ten years to needing income from investments.
  • Moderate/Aggressive with less than ten years to needing income from investments (including already taking income) and Moderate/Conservative with more than then years to needing income from investments.
  • Moderate/Conservative with less than ten years to needing income from investmetns (including already taking income).

The moderate/aggressive close to needing income and moderate/conservative far from needing income invest the same. In essence, they are both moderate investors whose definitions overlap due to their particular time horizons. This is so because the moderate/aggressive investor generally has the temperance and portfolio characteristics (more money) to be more aggressive while taking income, and the moderate/conservative investor has the time frame to be at the more assertive edge of their long-term investment strategy.

I would suggest that all investors categorize themselves into one of these classes and act accordingly. It is my experience that very few people are truly moderate/aggressive investors. Those who are, genereally have the following traits: 

  • above average income or larger account balances
  • considers “optionality”
    • understanding that all-in (i.e. fully invested) all-the-time is not the best strategy
    • willingness to accept volatility as an opportunity rather than as a risk
    • patience to wait for good opportunities that offer asymmetric upside

Energy

Oil and gas continue to be in the news as the price per barrel for oil has fallen below $50. Many pundits who missed predicting the oil price collapse have come out of the woodwork to give their unqualified opinions. There are not many who understand what the story really is with oil. Be slow to accept any analysis that oil will be low for five years or longer. It is a silly argument from people who did not understand the dynamics in the first place.

I would put my credentials – covering enegy for many years, predicting the shale boom, predicting the oil price fall to the low end of the natural range or possibly lower – up against most when giving an outlook for oil. My outlook can be found at the American Resource Boom Letter.

In short, about a dozen oil and gas company’s stocks have become bargains. There will be more that become bargains as they fall in sympathy over the next two quarters with companies that are exposed by their earnings reports as being on the verge of declaring chapter 11 bankruptcy or being targets of take-unders, for example I believe Linn Energy (LINE) and EP Energy (EPE) are in danger of one or the other. 

Oil will firm sooner than later and ultimately rise back to about $110/barrel two to four years out. For long-term investors, the drop in oil and gas company stocks is a major developing opportunity not to be missed.

 

 

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