Surviving the Bear

The Cabot Emerging Markets Timer, which looked last week like it might climb back on top of its moving averages, has now fallen back again. This isn’t a time to be obsessing about why investors have soured on stocks. Maybe it’s all about China, including the slowing economy, yuan devaluations, falling foreign currency reserves, non-performing loans, floundering government owned businesses and an aging population. Maybe it’s Brazil’s Petrobras scandal, political corruption, inflation and low oil prices. Or maybe the problem is still the bad apple (Greece) spoiling the barrel (Europe). It might even be some anxiety about rogue regimes like Russia and North Korea and their potential for disruption.

Whatever the causes, investors are extremely skeptical about banks—take a look at the charts of Bank of America (BAC) or Deutsche Bank (DB) over the last six months.
Oil is still going in the tank. And the S&P 500 and the Nasdaq Composite are both below their August 24 lows.

There have been a few areas of positive action, but not many. Gold, for instance, has been advancing at an accelerating rate since the middle of December. And we are seeing a little resilience among the most beaten-down sectors, such as industrials and commodities. This has helped EM stocks hold up decently during the past few weeks.

It’s a little disconcerting not to know where the market will get the impetus for further advances. In 2009, as the world and world stock markets were coming out of the Great Recession, economists and professional market predictors said it might take five or six years to get things back to normal. And it turns out they were right, if maybe a bit too optimistic.

Next month, March 2016, will mark six full years from the start of the market’s dramatic recovery from its over-the-falls experience in 2008. The S&P 500 bottomed that March, and rebounded strongly, recovering its 2007 high in 2013 and tagging a recovery high at 2,035 in May 2015.

But after that May high, the Index spent an unusual six full months trading sideways from February through August as investors couldn’t find compelling reasons to bid the market either up or down.

That’s when the collapse of the Chinese stock market finally caused six months of anxiety to precipitate out of the market, dropping the S&P from over 2,100 to 1,867 in just five trading days. Then, after a failed September rally, the Index dropped to 1,872 near the end of the month.

Of course that double bottom produced a rally back to 2,100 in October, but that was just investors doing what the market had taught them to do. From March 2008 to August 2015, every correction in the market had been a bargain-hunting opportunity. Every dip was buyable (if you picked the right stocks) and no damage was lasting.

That kind of run can’t last forever. The market had conditioned investors to expect a rebound, and that kind of optimism isn’t easy to stamp out. That process of beating optimism out of investors seems to be what’s happening now.

We have been in a cautious stance since November and outright defensive since December, and our cash position is now north of 70%. This has protected the portfolio from the worst of the market’s predations. Our watch list has strong stories and our list of previously owned old friends is ready for action once the market turns up again.

This is an excerpt from Cabot Emerging Markets Investor, which seeks to capitalize on the enormous potential in emerging market countries. Chief Analyst Paul Goodwin has been a researcher and writer for over 30 years and a member of the Cabot investment team since 2005.

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Paul Goodwin can be found on Google Plus.

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