The stock market has had a nice rally, up 30 per cent or so from the low on March 9. But by the time you read this, the rally could be out of gas. If this rally is out of fuel, I’m not sure there is any place to hide, or any place to invest except cash.
I don’t want to be a pessimist, but there are good reasons for almost all stocks to drop if the rally is over. Here are a few as I see them:
First, there is still lots of debt to settle. In spite of what we see and hear about bank shares turning up, there’s a lot of debt to settle around the world and it could take years to do so. Yes, CitiGroup (C), Bank of America (BAC) and Wells Fargo (WFC) and others have announced impressive earnings or big jumps in earnings, but we suspect these are accounting earnings, not actual dollars of cash flow earnings. By this, I mean it is possible that these institutions included as income some of the value of the toxic assets they wrote down late in 2008. These bank stocks will be hurt if the economy has trouble dealing with all the debt in the big wide world.
Second, most bear markets run over two years. This bear is only 17 months old, so odds are this bear is not over. If the bear continues, investors have no place to hide. Pretty well all stocks dropped in value in 2008 around the world, so besides cash and maybe gold shares, there really was no asset class to run to. We owned shares in gold, oil and some aggie companies and that helped, but we also sold covered calls all year, which brought in enough cash to help reduce losses. Yes we could do that again but it’s a hard way to beat the bear. It’s a lot easier to go to cash and stay in cash until the MACD starts to flatten on the bottom of a lot of stocks, after they dropped.
The price of oil could drop because of a slowing economy. The price of gold could drop because the International Monetary Fund (IMF) is supposed to sell 403 tonnes of gold to raise cash to help poor countries.
Many industrial companies could drop because the price of their shares has come up more than their upcoming earnings justify. If China slips into a recession instead of growing at six per cent, then resource stocks will drop. Aggie stocks look promising, but if stocks start to drop, the pessimism likely will pull all stocks down.
More and more people are losing jobs around the world. This cuts into people’s ability to spend money and as spending drops and the speed at which money circulates drops, corporate cash flows and profits will drop and so will the price of stocks.
Plus, more people are becoming savers, which reduces spending and slows down economies. So there are reasons why most stocks could drop.
REASONS FOR OPTIMISM
People and companies do adjust to slower economies. Sooner or later, people feel they have saved enough. Governments and central banks around the world are putting out massive amounts of money, which will stimulate economies.
The massive debts that need to be settled still far outweigh the money these stimulus packages are going to bring in, so stocks could easily drop big time one more time. Yet, more and more investors believe that this would be the last big drop. This could do a couple things. First, it could prevent or certainly reduce a big drop to a small drop. So any drop in the price of stocks could, would or should begin to attract money from the sidelines.
We also can use protection systems to protect our portfolios even if stocks drop. First as I did in 2008, we could sell calls in the money as stocks drop and bring in cash. We could also buy puts as downside protection for our stocks for a few months out and keep selling covered calls.
That would do two things. First, selling covered calls would continue to bring in cash. Second, as the price of a stock falls, the value of the put we buy would go up which would help protect the value of our portfolio. And if stocks didn’t drop, that put would just expire worthless.
These are all strategies most people do not know. They take work, but they are teachable and readers of StocksTalk know this stuff and more important when to use it and when to let a stock run. While many investors saw their portfolios mauled and torn up by the bear market, for me this bear market was a lot more fun than the bear of 2000 to 2003. And I think we are even smarter now, or at least certainly have more skill. It gives me confidence that we can deal with whatever the market throws at us.
On another topic, the government of Manitoba set up a new rebate plan that lets any graduate who chooses to stay in Manitoba recover up to 60 per cent of tuition paid since December 31, 2003. I worked through one rebate in early April and it looks like most tuition qualifies if you graduated in 2007 or later.
The amount you can recover per year is limited. For example, if you paid $13, 000 in tuition, the total rebate available is 60 of that, or $7,800. Each year, your rebate is 0.1667 multiplied by the balance. So in the first year, you would get a refund of $7,800 times 0.1667, or $1,300. If you don’t pay enough tax to claim the whole rebate, you can claim it in future years.
You will need receipts for your tuition going back to 2004 but if you don’t have them you should be able to find them on the Internet and print them off.
If you don’t apply for the rebate of tuition at tax time this year, you can always do it later in the year and amend your tax return at any time or carry it forward and get the rebate next year. If your province has a similar rebate, please let me know.
Andy lives in Winnipeg. He manages his own portfolio and publishes an investment newsletter called StocksTalk where he explains in detail what he does with his stocks. To get StocksTalk free for a month Google StocksTalk.net,click on free month, go to form and fill in your name and email address, or just send an email to him at [email protected].