What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.
Evacuation Station
Equities have experienced nothing less than absolute evacuation during the month of August. The intolerance of individual and institutional investors for increased volatility and risk is abundantly apparent as memories of past crisis situations incinerating capital are still fresh in the mind of many.
It has been quite sometime since I have witnessed such a symphony of fear as measured by various indicators and surveys. Here is a brief list along with the appropriate matching illustration:
1. Inflows into money market funds are skyrocketing.
2. Flows out of equities have been massive during August. This has been the largest 5 day outflow in 15 years.
3. Investor exposure to U.S. equities has only twice been lower in the past eight years according to Bank of America.
4. This according to Bespoke: “Following this week’s decline, bullish sentiment has now been below its bull market average of 38.1% for 21 straight weeks, which is the longest streak of the entire bull market. Taking a longer term look, bullish sentiment has been below 40% for 25 straight weeks now. We haven’t seen that long of a streak since August of 1994! “
https://www.bespokepremium.com/think-big-blog/bullish-sentiment-back-on-the-decline/
5. The put/call ratio has now recorded the most bearish reading of this entire bull market to date as expressed by the 2 & 5 day moving averages of the ratio.
What we have experienced is a wholesale evacuation of stocks into illiquid trading conditions brought about by late summer disinterest. A vicious cycle, if you will, of self-fulfilling despondency that is more based upon nightmares of past investor experiences than any semblance of economic reality.
What this means for investors is very simply opportunity. Contrarian theory works exceedingly well during secular bull markets, both in terms of predicting points in fear that deserve additional allocation AND points of greed that require the raising of cash in a portfolio. To date we have experienced numerous points of excessive fear, with August being the most substantial example. We have, however, been reluctant to witness any real greed driven, speculative excess as is the hallmark of true market tops.
Given the rapidity with which investors are prone to terror, it may be some years yet before we experience such excesses in greed warranting any type of real market top. Until then, declines met by unmitigated investor fear will be a buying opportunity for investors.
Decisions...Or A Lack Thereof
Given the abundance of volatility that investors faced in August, it is not surprising that the decision making matrix of most investors has been compromised to a certain point. What is clear about corrections during bull markets is that enough volatility paired with an overflow of mostly disinformation causes what are otherwise simple decisions to descend into a realm of utter and complete disorder. That disorder gives way to either liquidating a portfolio of stocks at an inopportune time or selling stocks on the first bounce or soon thereafter. In either case, it is a decision based on false influences that deter an individual precisely at the time they should be emboldened.
There has always been something about flashing red and green pixels that brings out the idiot in otherwise rational individuals. This applies for all investors, regardless of background, methodology or scope of assets under management. There isn't a person that isn't susceptible to the inherent emotional manipulation that the markets seek to probe on a frequent basis.
The most successful investors find ways to work around the manipulative characteristics of the market by developing a structure that leaves them less susceptible to errors during such periods. Feeding into manipulation is squarely the decision of the individual being manipulated. Those who have no idea that manipulation of emotions are taking place, more than likely should not be managing an active portfolio of stocks in the first place.
My own method of dealing with August was more along the lines of the theme that has dominated the portfolios for all of 2015: Doing less in order to achieve more. Overall, this has been the most inactive year for both initiating new positions and liquidating existing positions in sometime.
If there was reason to act, the action would have been seamless. The portfolios are unlevered, simple structures that currently hold five names. So the structure of the portfolios naturally compliment simplicity. Decisions with respect to allocation and risk should be effortless within such a structure. It is purposely designed this way to avoid confusion, as my ability towards efficient decision making declines relative to the number of decisions I am faced with any given moment.
Regards,
Ali Meshkati
