ECB Kicks The Can Down The Road; Was This Our 'September Surprise?'

In 15 words or less: I don’t think so. I think there is a less pleasant surprise yet to come.

Mssrs Bernanke and Draghi continue to blow hot air in their respective balloons and, so far, investors have fallen for it. Neither of those economics wizards have had to actually do anything as long as they keep promising they will do something. Tomorrow.

Maybe I’m the fuddy-duddy who will be surprised if markets roar ahead to sustainable new highs on this low volume we’ve seen all summer. But maybe, instead, it will be those investors whistling past the graveyard, buying on talk alone and taking very large risks.

The sound of balloons popping would be mighty scary in a graveyard at the 11th hour… If you believe as I do, you might base your investments on the following strategic considerations:

(1) According to Dow Theory, the Transports must confirm the rise in the Industrials for the bullish signal to be valid. Currently, the Industrials are rising… but the Transports are declining.

(2) Most investors are usually wrong around major turning points. This isn’t a slight to any of our intellects or critical thinking skills; it merely means that if we are bullish we are most likely already buying, and if we are buying we may be running out of investable funds to keep buying even more. Right now, the American Association of Individual Investors poll shows more bullishness than at any time since April 2nd, when the S&P was at 1419, and after which it plunged back to 1278, less than one point from where it began the year.

(3) Unlike Wall Street traders and individual investors, who are buying into this cyclical rally, the corporate insiders are not. Those who arguably know more about their own company’s prospects are selling at a rate approaching 5 times their number of purchases. This level of selling almost always presages at least a short-term market top.

(4) Advisor sentiment is as bullish as investors are. Most advisors are trend-followers who pile on when things look good, after the trend is in place, and hold on longer than they should, as the trend returns to earth. So as a group they are seldom right.

(5) Nothing has changed in the geopolitical arena. Just because everything is quiet on the Western Front that doesn’t mean it will stay quiet. We are priced for perfection, and perfection does not include China decelerating at an accelerating rate, Iran attempting to close the Strait of Hormuz, Japan falling further behind, Europe promising unlimited bond purchases subject to “audits and other considerations,” US joblessness remaining high, home prices falling after summer ends, etc.

Given all this rampant bullishness, it bears noting that the S&P was at 1400 on April 26. It ended the month of August at 1407. 7 points in 4 months. And as of this writing the S&P is at 1432, up 29 in just a single day! Does that make it a buy? Or a sell…?

Of course, if you are in the “other camp,” you don’t worry that China's economy is in deep trouble. You don’t worry that insider selling is near a record high. You aren’t concerned by the uncertainty of a very important election which will have radically different outcomes depending upon who is elected. When you hear the term “fiscal cliff,” which will mean massive tax hikes and serious belt-tightening, you say “fiscal schmiscal.” Who cares about the debt ceiling? Who cares about unemployment or falling housing prices or doing your best to protect your assets?
All you need to know is that Helicopter Ben is going to circle your house and throw hundred dollar bills into your back yard.

Even if we overlook the ethical considerations of rooting to see more joblessness, more people kicked out of their homes, and hollowed-out national and homeland security, just so one can make a few bucks in the market, there is something -- to those in my camp -- inherently stupid about only caring that you go up along with the other lemmings. But, hey, the financial media loves you for it.

Marketwatch’s big headline at the end of August was, “Market Up For 3rd Straight Month!” That’s true, but until Dr. Bernanke’s one-day goose of the market, it would have finished down for the month. Slim reward for going out so far on the risk limb.

Sadly, this just doesn’t act like a market that wants to go higher. As intelligent investors, we need to ask not, “Did I mirror or beat the market this week, month, year?” but rather “Did I do the prudent thing to protect my capital and then deploy it well and quickly when there was a clearer opportunity?”

In 40 years in this business I’ve been right and I’ve been wrong. But wrong usually meant only lost opportunity or being early in my purchases. I lost opportunity from mid-2009 to mid-2011 by focusing on fundamentals rather than going along with the Fed’s goosing of the markets (and horrific failure to goose the economy, which was their charter.) But that horse has been rode so hard that I believe it is, at best, a 1:1 payoff even if QEIII is announced.

So what’s next? What surprise might be in store for September? If the “Don’t Worry, Be Happy -- Helicopter Ben is going to do QEIII” crowd is correct and if -- a big if -- QEIII isn’t already discounted in the current market level, I’ll be surprised and chagrined. Of course, since I have no axe to grind or emotional attachment to any particular point of view, I’ll take my lumps on our inverse ETFs and buy the great American and international companies selling for a song.

This has been a Fed-induced relative momentum market, as the Fed seems to think its job is no longer steady employment and low inflation, but keeping the stock market elevated. As a result, some great companies that are sensitive to the rotten economy are languishing. The big infrastructure and engineering firms like Siemens (SI), Chicago Bridge and Iron (CBI), Cummins (CMI), Joy Global (JOY), ABB (ABB), Deere (DEERE), and Caterpillar (CAT) are already mouthwateringly close to leaping off page 1 of my Watch List, as are some of the undervalued energy firms like Total (TOT), Seadrill (SDRL), the Norway 30 ETF (NORWAY30.L) (20% of its portfolio is Statoil, near 40% energy-related,) Statoil (STO), Petroleum & Resources (PEO), Penn Virginia (PVA), Encana (ECA), Canadian Oil Sands (COS.TO), Suncor (SU), GasLog (GLOG), Boardwalk Pipeline (BWP) and Natural Resource Partners (NRP).

It’s OK being right but a lot more fun being rich, hence my agnosticism when it comes to guessing / predicting / trying my darnedest to figure out where to place our funds during what I see as this particularly dangerous month in this particularly dangerous year. What we’ve lost so far is mostly just opportunity and opportunity is always knocking if you are willing to hush up and listen.

Ah, but what if the concerns I’ve outlined thus far, or even one or two of them, work their way into the consciousness of investors and traders? Then September will be what I feared this summer might bring. I have been wrong so far, but what if I was merely too early? Then we could easily see a 12-16% correction, which would take the averages back to where they were, or below where they were, at the start of the year.

I still expect a fine conclusion to 2012. But even a great market needs a pause every now and again to let a little air out of the balloon so it doesn’t explode. If September proves to be dreadful and October a toss-up, we will have that marvelous opportunity to take advantage of what would then be the prevailing bearish sentiment in October to load up on the kinds of companies already in our portfolios as well as those that will be before the year is out.

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