Frank Thoughts: The Rally
Frank Boland
April 15, 2010

In this edition of Frank Thoughts, Frank expands upon last month's topic "The Bond Market".  Frank examines closely the true catalyst for the bear market in equities and answers the question: Is the current bull market "just a rally" or the start of a long-term (secular) advance for equities?  


The other day CNBC, in conducting a survey, asked the question “Are you fearful of investing in this market?”  72% responded “yes” while 28% answered “no.”  Given the response, it’s difficult to imagine how the stock market has actually gone up over 70% the past 12 months!  The higher it goes, the more fearful and disbelieving people have become.  This is historically an unprecedented experience.  It begs the question … why are investors acting this way?

Part of the answer may be primal.  There is a large percentage of the investing population that believes investment brilliance lies in timing markets.  Of course one of the richest men in the world, Warren Buffet, has never timed the stock market.  But that is against the impatience of our culture, especially in making money.  Most investors want to be instantly rewarded for their prescience in judging which way the coin of market direction will be flipped.  Having lost the previous bet, by getting out a year ago, they are now gripped with fear that if they come back into the market “the rally” will be over.  From its beginning on March 9, 2009, it’s been called by almost everyone … a “rally.” But what if it is not a rally but a long- term secular bull market? 

  In truth, the market’s sharp and extensive decline had absolutely nothing to do with the stock market.  This was a fixed income crash ...  a highly speculative and severely leveraged (30 to 1) institutional bond market disaster!   Equities were the only assets of value and as a consequence were  sold by institutions that had lent money to hedge funds who were equally leveraged.   Stocks were the only real assets of any knowable value.  So they were sold.  It was institutional survival … and it was that simple.

I learned this lesson 45 years ago.  A client would hold a favorite speculative position in his portfolio ...  a position he could increase with margin.  As the stock went up, his buying power increased and he bought more.  Then the stock would start to decline (Think bonds).   Eventually, the decline caused a margin call.  Would the client reduce the size of his position?  No way!  He would sell other stocks to meet the call.  It’s called denial.  And yes the speculative, now core, position would continue to go down creating additional margin calls; calls met by, yet again, selling other stocks.  Ultimately the forced sale of the entire position by the lender resulted in a total wipeout of the account.   This is exactly what happened with today’s institutional accounts.   Though unrelated to the margin calls, stocks were sold to meet the fixed-income created calls.  Billions and billions and billions worth of stocks were sold.  All unrelated to the calls.  And then everyone felt poor; and for a moment in time, the economy stopped.

When will “the rally” be over?  The last fixed income (core position) margin call was met March 9, 2009.  This has not been a rally.  It was the first year of a secular bull market



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