Ostrich Investors 2

By: Adam Hamilton | Fri, Aug 27, 2010
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Ostrich investors are a major driving force in today's financial markets. As the name implies, they are hiding their heads in the sand like the popular literary perception of the king of birds. Burned in 2008's epic stock-market panic, they have shunned active investing ever since. Trillions of dollars of their capital languishes idle on the sidelines, earning zero in money markets or near-record-low yields in Treasuries.

I can certainly sympathize with them. In the heart of that brutal once-in-a-century stock panic in October 2008, the flagship S&P 500 stock index plummeted 30% in a single month! Elite blue-chip stocks long considered safe failed to weather that fear storm well. Because the economy has been slow ever since the panic, countless investors fear another extreme selling event. They still want nothing to do with stocks.

The reasons for investor anxiety today are legion. Investors fear a new recession, the ever-popular double-dip scenario of heading back into economic contraction. They worry about the sorry state of the jobs market, consumers' ability to spend, and the shaky housing market. They fret about the incessant and stifling growth of big government in Washington, and the Democrats' threats of record tax hikes.

It's not a pretty environment out there, so it isn't illogical to hide heads in the low-yielding sands of cash and bonds. Unfortunately for ostrich investors though, this strategy is doomed to failure. While it is challenging psychologically, the active investors braving these stock markets are thriving. Our wealth is multiplying while ostrich investors' is stagnating. Those hiding out too long will never catch up.

I wrote my original ostrich-investors essay 16 months ago, fresh out of the despair lows in early 2009. At the time countless worries plagued the markets. Economists were convinced we were heading not into a recession, but a depression. The newly-elected Democrats promised smothering tax increases on investors. And the S&P 500 (SPX) had averaged just 808 since the despair low 6 weeks earlier.

If there was ever an environment that encouraged ostriching, early 2009 was it. If you had moved your capital to cash then, you'd essentially have the same amount today. But boy the opportunity cost of hiding on the sidelines has been staggering. Between March 2009 and April 2010, the SPX blasted 80% higher in a massive post-panic recovery. Believing the pervasive gloom and doom back then nearly cost you a doubling of your capital!

Although the stock markets have been volatile and stressful, the opportunities have been great. In 2009 the SPX rallied 23.5%. Yet in our popular Zeal Intelligence monthly newsletter, the average annualized gain on all the stock trades we realized last year ran 45.0%. In our weekly Zeal Speculator, where we trade more often and take more risks, our average stock trade in 2009 enjoyed an 88.9% annualized gain.

As of the middle of 2010, the SPX was down 7.6% year-to-date. Yet our average Zeal Intelligence stock trade closed this year had seen a 73.7% annualized gain (64.8% absolute)! Of course these averages include all our losing trades too, full performance data is always posted on our website. Despite all the fears and anxiety floating around, there is lots of money to be made in these markets. Active investors have a good shot at winning some, but ostrich investors are guaranteed to make nothing.

As investors we carry a huge burden, we are the financial stewards of our families' futures. If we make wise decisions, our capital will grow and our families' lives will improve. Similarly, poor decisions today will greatly reduce our future wealth. No one cares more about your financial future than you do, your active stewardship is crucial. Hiding out on the sidelines is an abdication of this stewardship responsibility, a flat-out failure. Tough markets require different strategies, not capitulating and cowering.

Provocatively, even the Bible speaks out on this principle of stewardship versus ostriching. Jesus Christ's famous Parable of the Talents is chronicled in Matthew 25 and Luke 19. A nobleman who would be traveling long and far entrusted his servants with portions of his capital. The good servants went out and invested it, growing it for their master's return. He praised and rewarded them. But one servant was afraid, so instead of investing the capital he was given he hid it. He was a first-century ostrich investor!

Far from being commended for returning the cash unharmed, this ostriching servant was called "wicked and lazy" when the master returned. He was effectively fired, with his capital given to a good servant who had wisely invested and multiplied his own capital allocation. While this parable teaches deep spiritual truths to Christians, its literal surface application on the financial front is no less valid. As investors our responsibility, our moral duty, is to multiply our capital, not hide it away.

These post-panic markets are certainly far-more challenging than the pre-panic ones, but that just means we have to step up our stewardship efforts. Investors can't just buy anything and hope a rising tide lifts all boats. They can't just buy anytime and hope their stocks will eventually rise. They have to study the markets, learning about their cycles and finding stocks that will thrive in this environment.

If you've been ostriching since the panic, you can't change the past. Though you could have nearly doubled your wealth since through active investing, there is no sense beating yourself up about it. But you can change the future. Your decisions you make today will determine how much capital you have in the coming years. If you hide in cash, what you have today (minus inflation) is the best you can hope for. If you get back in the game though, fighting your anxiety, you could achieve a much better financial future for your family.

The opportunities are truly vast right now in the stock markets, despite their big gains already booked since the panic lows. In nearly 100 weekly essays written since that panic, by business partner Scott Wright and I have detailed many awesome opportunities. Most of the key post-panic trends that have rewarded us and our subscribers with such massive realized gains in the past couple years are still ongoing.

To understand why, you have to consider cycles and sentiment. Stock markets move in great 34-year cycles I call Long Valuation Waves. The first half is a 17-year secular bull, like we saw from 1982 to 2000. The second half is a 17-year secular bear, like we've been experiencing since 2000. Within these sideways-grinding secular bears, smaller multi-year cyclical bulls and bears oscillate. Check out my essay delving into these critical cycles. We are in one such mid-secular-bear cyclical bull today.

Cyclical bulls within secular bears average 3 years in duration, but can be as short as 2 or as long as 5. Yet our current one was only 13 months old in late April when the stock markets peaked before their recent correction. This bull was far too young to give up its ghost then, which strongly suggests it is very much alive and well today. I recently wrote another essay explaining all this in depth.

In addition, secular bears have giant horizontal trading ranges. In SPX terms our current one runs from roughly 750 on the low side to 1500 on the high side. We hit this upper resistance in late 2007 at the top of the last cyclical bull, and lower support in late 2008 at the height of the panic. Today the stock markets remain low within this secular-bear trading range.

The upshot of our position today in these critical cycles that all investors should study is that probabilities strongly favor the stock markets rallying from here. These bull-bear cycles are strong and nearly ironclad, nothing stops their ultimate progression. All the news you hear every day, all the anxiety and worry, is nothing but ephemeral noise. The markets are always fretting about something, but it is soon forgotten (remember European sovereign debt, the oil spill?).

With our position in the bull-bear cycles firmly on investors' side today, ostriching now is as irrational as it was in early 2009. Sure, you can bury your talents in cash over the next year and dig them up with just minor real losses after inflation. But that is not investing, it is just poor stewardship. If you take a little time to learn about the markets and seize the opportunities, you could really grow your capital in the coming year.

In addition to the cycles, all this rampant fear and anxiety itself is extremely bullish. Sentiment is all-important in the financial markets, driving most short-term price action. Sentiment is like a giant pendulum, perpetually swinging back and forth between greed and fear. When stock prices have long been rallying to highs, greed reigns supreme. When they have been falling to lows, fear dominates. But like a pendulum, once either extreme is reached you can be sure the next extreme will be the opposite one.

There is no doubt that this summer has been dominated by the fear side of the sentiment continuum. The stock markets have been weak thanks to the major SPX correction in May and June. Investors are scared of countless threats, worried that something even worse is coming. As is always the case when stock markets are weak, bearish and pessimistic theories dominate newsflow and consciousness. When prices are down, investors want to be scared and look for reasons to rationalize their emotions.

Yet it is fear episodes that birth all great rallies. Eventually fear and anxiety drive everyone interested in selling anytime soon into pulling the ripcord and bailing out. And once this selling-exhaustion threshold is hit, there are no more sellers left. Then no matter how bad the news is, the markets start rallying anyway because only buyers remain. And after this new rallying is established for a few weeks, newsflow turns positive as investors start feeling greedy and look for justifications to buy.

The great sentiment pendulum endlessly swings from greed to fear and back again. And since it spent most of the past few months deep into fear territory, the only place it can go from here is back towards greed. The only thing that can drive widespread greed is a big rally. Thus in pure sentiment terms, the stock markets are perfectly set up to enjoy a major rally in the coming months. The markets abhor extremes, and fear has ruled for too long. Greed is overdue to make an appearance.

If you study the markets, you have no choice but to acknowledge the bull-bear cycles and the greed-fear swings in sentiment. Many ostrich investors I've talked with over the past year have some level of awareness of cycles and sentiment. But they still argue that hiding in the sand is rational, because they fear another stock-market panic or crash. Together crashes and panics are extreme selling events.

From the widely-hailed Hindenburg Omen in the news lately, to all kinds of more obscure theories, perma-bears offer dozens of reasons why we face a crash or panic this autumn. Never mind that these perma-bears always think a new crash or panic is imminent! If you follow one of these guys, read what he was predicting back in early 2009. It will be a crash or panic, not the massive rally I predicted then. Gloom and doomers are broken records, they perpetually forecast calamity and lead investors astray.

An extreme selling event in the coming months is terribly unlikely, its probability approaching zero. Ostrich investors need to understand this, as constantly expecting an event with exceedingly-low odds of occurring is no excuse for burying their capital in the sand. There are a couple key reasons why we won't see a crash or panic this autumn. Today's bull-bear cycles are in the wrong place to spawn them and the last extreme selling event happened too recently.

Crashes, a 20%+ plunge in the stock markets in a matter of days, only occur at one very specific time in cycles. Crashes always erupt near multi-year highs deep in secular bulls, like in 1929 and 1987. Crashes are born in extreme greed when retail investors are fully deployed and almost no one is hiding in cash on the sidelines. Obviously today with widespread fear and ostrich investors hiding trillions in cash, this environment is all wrong for a crash. And the April SPX high of 1217 was far below the October 2007 high of 1565 at the end of the last cyclical bull. A crash ain't gonna happen folks.

Panics, a 20%+ plunge in the stock markets in a matter of weeks, also only occur at one very specific time in cycles. Unlike crashes starting from multi-year highs, panics cascade out of lows in cyclical bear markets. A bear persists for a year or so, mauling about 25% out of the stock markets. Then some high-profile catalyst ignites a frantic rush for the exits, and the resulting intense selling drives another 20%+ loss in a matter of weeks. Like crashes, panics require heavily-deployed retail investors. People have to be in before they can panic!

We aren't at the end of a multi-year bull near multi-year highs, so no crash is coming. We aren't a year into a cyclical bear near lows, so no panic is coming. And extreme selling events can't happen in an environment like today's plagued by ostrich investors, when trillions of dollars are already hiding outside of the stock markets. Extreme-selling-event-magnitude declines require fully-deployed investors. Even Wall Street often acknowledges how chronically underinvested people are today.

Proximity to the 2008 panic is another strong argument against another extreme selling event anytime soon. Extreme selling events are so scary that everyone without nerves of steel is driven to sell. Some of these investors are so discouraged they never come back, and others gradually tiptoe back in over years. So throughout market history, you always see at least a decade between extreme selling events. It takes that long after one for enough investors to quit worrying and get fully deployed again.

So ostrich investors can't latch on to some perma-bear's flawed extreme-selling-event thesis and use that as an excuse for abdicating their family's financial stewardship. Probabilities are virtually zero of seeing another panic or a crash anytime in the coming years. And without extreme-selling-event worries, the bull-bear cycles and sentiment pendulum become even more compelling. They are very bullish today.

Ostrich investors also bring up the horrible state of Washington as an excuse. They understandably worry about our out-of-control government's epic debt binge. And the way the Marxists (Democrats using class-warfare rhetoric) want to raise job-killing taxes on hard-working American businessmen. And the terrible encroachment by the federal government into all aspects of our lives through insane overregulation.

There is no doubt at all that the Democrats' terrible anti-prosperity philosophy, monstrous overregulation bills, and endless threats of higher taxes have strangled this post-panic recovery. But this isn't the first time we've had an abominable government in America. Remember Jimmy Carter? The beauty of the United States is we can vote out these thieving socialists. We've done it before and we'll do it again in November and 2012. Don't extrapolate out our current bad government into infinity. This too will pass.

Realize that oversold or undervalued stock markets can rally strongly even when we are saddled with a terrible government for a season. Remember that back in early 2009 we had the misfortune of the same openly-Marxist Obama Administration and prosperity-hating Democratic Congress we do today. Yet despite all the despicable things Washington has done to us taxpayers since then, the SPX is still up 80% at best since its lows!

Ostrich investors have really lost out since the panic, giving up nearly a doubling in their wealth. But they don't need to bear such crushing opportunity costs forever. If you have been hiding out in zero-yielding cash or low-yielding bonds, get back in the game! Start redeploying a small fraction of your capital in stocks. As you get more comfortable and enjoy gains, gradually move more of your capital back into stocks. Eventually you'll be out of ostrichdom and back into wise financial stewardship of your family's future.

We can help you. At Zeal we study the markets constantly, always looking for high-probability-for-success trading opportunities. We specialize in commodities stocks, the great secular bull market of the past decade. We publish acclaimed monthly and weekly newsletters analyzing the markets, explaining what is going on and why, and detailing which stocks we are buying and selling (and when) to ride these trends. Our subscribers have been richly rewarded by our trades even in these tough times. Join us!

The bottom line is there is no excuse to be an ostrich investor. Hiding your capital in the zero-yielding cash sands is a failure, a millennia-old abdication of stewardship responsibility. Tough markets are not as easy to grow your wealth in as normal markets, but with a little time and effort you can still thrive as an investor. Get your anxiety and fear in check, buckle down, and start investing to win again.

The markets are actually very bullish right now, with almost no chance of an extreme selling event like the perma-bears perpetually prophesy. Stocks are in a great place in their bull-bear cycles to rally strongly in the coming months. And the very poor sentiment we've weathered this summer ensures the next sentiment swing will be towards greed. The only thing that can generate it is a major stock-market rally.

 


 

Adam Hamilton

Author: Adam Hamilton

Adam Hamilton, CPA
Zeal LLC.com

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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