Author: Chris Rees, TenStocks
Covestor model: TenStocks
Disclosure: Long TWM
We added TWM, an inverse ETF, to the portfolio in November. We continue to be concerned about the global debt crisis and adding TWM provides a degree of downside protection in the event of a significant market selloff. Likewise, it will dampen performance if the market rallies.
Our first priority is not wildly swinging for the fences, but rather preservation of capital. Over two decades of investing we have made plenty of mistakes and expect to make more in the future, but our main focus has always been on erring on the side of caution. Right now, several of our positions represent compelling long term risk-adjusted value but we have decided not to increase our exposure to these names, as we already own large positions in them. If we are right, we will do okay with what we have; if we are wrong, we will lose enough. However, we may well revisit that decision if the market falls enough for us to unwind the TWM position.
Right now a lot of bullish market participation is based on the idea of the S&P 500 reporting earnings of around $100 in 2012. With the market selling historically at a price to earnings multiple of 14, this implies a fair value for the S&P at around 1400. As I write, the S&P 500 is at 1256 (date – 5th or 6th). This suggests to the bulls the market is about 10% undervalued, and hence a buy. We don’t agree. Our work suggests the likely as reported earnings for the S&P 500 over the next five years will be closer to $85. Put a 14 multiple on that and fair value for the S&P 500 may be closer to 1190. This does not make the current market a screaming buy.
Forecasting future market moves, especially in a time of rampant manipulation and distortion of the basic laws of economics by politicians and central banks, is treacherous. We may be wrong. The constant injection of happy juice and Prosac along with ample use of smoke and mirrors, may keep the market suspended above reality for a long time. For the committed bulls, to paraphrase Pink Floyd, it may be a case of being Comfortably Dumb.
We think, given the abundant stress in the global economy, there is a high probability of the S&P seeing 1050 before it sees 1400.
With cash and our TWM short, we can sleep better at night and wait patiently for the market to better reflect the true risk in this current market. When it does, it will present opportunity for those with buying power. We intend to be one of them.