PREPARING FOR A DROUGHT
An unusual experience came to be in recent weeks. Unusual in the sense that over the past several years it has seemed that taking comfort in fear has trumped the emotion of being driven by greed. When that particular dynamic is in place it results in value creation, particularly in small-cap land where I dwell, that patiently occurs over a very long period. In other words, investors who spot an opportunity have plenty of time to accumulate before the hoi polloi become aware of the opportunity. That dynamic has changed.
For the first time in years, I had a brilliant small-cap opportunity that I discovered run away from me within days of its discovery. I have become spoiled by the market of the past several years. It has been a market where I could patiently discover an opportunity, ponder that opportunity for days or even weeks, begin typing my research report, accumulate and then publish the research on my timeline, without worry of a runaway train to the upside jeopardizing this process in any form.
That has changed. In addition, opportunities in general are becoming more difficult to discover as entities of all classifications seek validation through wealth creation in the equity markets. Now before you get carried away with feelings of premature contrarianism brought on by the erroneous mindset that an accommodating equity market equals pending disaster, let me remind you of a few relevant facts:
1. The major averages Dow, S&P, Russell are just a few months into all-time highs. Furthermore, these moves are being confirmed by the important "periphery averages", such as the Dow Transports. We are closer to a beginning than we are an end of this rally. I am talking long-term here. Not whether the markets are going to pullback in September of November of this year.
2. There remains a great deal of fear with respect to pullbacks. 3 percent pullbacks are feared to become 6 percent pullbacks. A 5 percent pullback is thought of as being a precursor to a 10 percent pullback. In the case of a 10 percent pullback, there will be talk of Armageddon, with Roubini and Faber leading a band mutant pessimists that only believe in gold, guns and reruns of Bonanza. This dynamic has and will continue to create support beneath the market during compromised periods.
3. Technology hasn't asserted any distinct leadership prowess over the market, as of yet. Technology has certainly been a participant in the rally of 2013, but it is far from leading the charge. That leaves an entire chamber of dry powder for the markets, especially as we get closer to Q4 and those whose livelihood depends on performance realize that they aren't getting a 5 or 10 percent pullback to comfortably buy into.
Whatever extreme optimism or talk of bubbles in any asset class you are witnessing is likely being produced for readership purposes alone. Additionally, how relevant will the traditionalist contrarian indicators be when 90% of market participants are contrarians who follow the same indicators?
I am left then with an eerie sense that my investing will be more and more dependent on names that I have profiled in the past, profited from or even lost money in, and are now sitting at a point where they provide a favorable buying opportunity. My recent rebuy of SPNS after selling it a short while ago is the perfect example.
There will be new opportunities that prove favorable. However, they will not become apparent in the rapid fashion of the past, with 13 opportunities profiled and invested in during 2012 alone. Thus far in 2013, there have been 6 opportunities profiled and invested in. I expect that no more than 2-3 more new opportunities will become apparent for the remainder of 2013.
While this is not a full drought of opportunities, it certainly isn't as accommodating an environment for finding favorable risk/reward opportunities that present potential for outsized gains. The only way to combat such an environment is through patience. One must also be diligent in taking advantage of those opportunities that do come around.
It is not a market where an opportunity can be missed. At the same, it is not a market where opportunities should be pursued due to lack alone.
Walking a fine line. What else is new?
