11/18/2008 Equities: Bottom Hunting Behavior Suggests Recent Lows Will NOT Hold

11/18/2008 Equities: Bottom Hunting Behavior Suggests Recent Lows Will NOT Hold

Written By: Matthew Xiarhos
Categorized in: NEWSLETTERS

A Message for Absolute Return Portfolio Management clients:

I am happy to report that our managed model portfolios had no equity exposure during the market collapse of the past two months which have witnessed 30%+ losses in both the domestic S&P 500 of large capitalization stocks and the Dow Jones World Indexes and a nearly 40% in the Russell 2000 index of small capitalization stocks.

Global Equity Markets

Market analysts and the general investing public alike have continued to wonder if the recent market lows will "hold" and if the market has bottomed out. It's an important question because a rally from these levels would support the contention that the government bailout program is working and that the worst is behind us. However, if the recent lows of October and this month are violated to the downside it would not only suggest that the bailout is not entirely effective but it would quite likely create a sea-tide change in sentiment from "hope" to "despair" and a resulting plunge in equity prices.

In addressing this important question, what is most curious about the past few weeks since our last installment is a growing swell in the bottom-hunting mentality of investors. I am seeing this reflected in Rydex mutual fund cash flow data in both the affinity for bullishly oriented funds and a disinterest in bearish/hedging/inverse mutual funds.

Keep in mind that at a market bottom we should see a high level of anxiety. This is typically evidenced by sentiment measures showing a low percentage of bulls (optimists), a high level of bears (pessimists) and cash flow data showing significant purchases of inverse funds (which go up as the market goes down). In other words, at market bottoms sentiment and behavior should both show fear of lower prices met with evidence of those trying to capitalize on the decline through purchase of inverse/bear funds.

Recently, however, we are seeing quite the opposite behavior. Sentiment polls continue to show a relatively elevated level of optimism (or hope). Similarly, Rydex cash flow data show evidence of purchases of bullishly oriented mutual funds and little interest inverse/bearish funds. And this, even after a nasty two-week slide of 15% on the S&P 500 and almost 20% in small-cap stocks.

Today, my indicators are now at levels that have accompanied market TOPS during this entire bear market decline. So, again, to see such heady levels of bullish sentiment both in spite of the long-term economic and fundamental problems AND following a two-week market rout illustrates an attitude of unfounded hope and speculative "THIS is the market bottom" mentality that is very unlikely to be rewarded.

In fact, my view is that the October and November lows WILL NOT HOLD and equity prices, once violating present levels, could plunge as panic and despair grips the investing public.

International Equity Regions

Our portfolios remain in a defensive position. The recent strength in the US Dollar is undermining returns of overseas investments for US-based investors. We remain 100% in short-term government bonds.

ASIA (ex-Japan) -

EMERGING MARKETS -

EURO -

JAPAN -

LATIN AMERICA (LatAm) -

USA -
(see Equity Style section for specifics)

Equity Style & Sector Trends

Our Domestic Equity Model continue in a defensive position at this time and our allocation to domestic equities remains 100% in short-term government bonds.

Investment Grade Bonds

Our Investment Grade Bond model remains on a BUY and bond prices have been rallying as inflation fears have given way to the realization that a full blown severe recession has stifled the global economy.

While the Government and Fed interventions are ultimately inflationary, the overwhelming pressure at present is for continued asset price erosion in nearly all asset classes and subsequent deflation which cause higher bond prices.

High Yield Bonds

Our models remain on a SELL for the High Yield Debt Markets and are invested 100% in short-term government bonds.

We expect the default rate on high-yield paper to move to double-digits over the next 12-18 months. The credit crisis most severely affects issuers with poor credit histories and high risk. These are the "sub-prime borrowers" of the corporate bond market and will face the greatest hurdles with respect to acquiring financing or refinancing. However, in time, this area will provide some handsome yields when a "return of capital" becomes more probable...

Inflation Hedge / Real Assets

Our Real Assets/Inflation Hedge model remains 100% invested in short-term government bonds. There is little chance that the Commodity or Gold segments would be purchased in the near-term.

GOLD Bullion - (GLD) - On a SELL.

Goldman Sachs Commodity Index (GSG) (largely energy ) and DB Commodity Index Tracking Fund (DBC) on a SELL .

Real Estate - Our models rank REIT's as a SELL.

f you have any questions about our research or Absolute Return Portfolios do not hesitate to call. We can be reached toll-free at 877-632-7491.

Absolute Return Portfolio Management LLC provides absolute return oriented portfolio management and institutional research on global macro trends including equity style rotation, global regional equity trends, short-selling and market neutral strategies as well as fixed income strategies. Contact us for information on account minimums and institutional research offerings.

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