Financial Fitness & Life Planning

Continuing to Pare Down Market Exposure
 
For most of June, the stock market appeared to stabilize from May’s malaise. In the last few days, however, the bottom fell out and the previous month’s heavy selling pressure resumed. Investors clearly lack confidence that the economy can withstand the significant sovereign debt problems abroad (and ultimately at home as well). The horrific Gulf oil spill is also adding to the negativity in the market.
 
The Internet/technology/stock market bubble of the late 1990’s was bailed out by the housing/mortgage/credit bubble of the next decade. This bubble was then rescued by government bailouts, borrowing and stimulus all over the world. This solution temporarily halted the panic and stabilized the economy.   Ultimately, however, all of the problems were simply pushed further down the road instead of being dealt with in the present. In my opinion, these policies have only made the problems worse in the long run by not allowing us to move beyond them. In the last two months, the market has quickly caught on that we have run out of artificial answers. At some point the pain must be felt, and regardless of good corporate earnings, investors are understandably focused on this fact.
 
Just as the market was able to climb out from the bottom while the economy was still bleak in early 2009, the market is also able to fall even when recent economic reports have been showing improvement. With the next leg of the financial crisis upon us, housing back in decline and unemployment refusing to budge from roughly 10%, the fundamentals are grim. Meanwhile, valuations are still elevated – not dramatically so, but overvalued nonetheless. Valuations, of course, can remain this way for long periods of time, but one can reasonably expect that at a time like this investor psychology should be fragile and therefore we are more likely to experience undervaluation as compared to the current levels.
 
As should be clear by now, I believe that recent market action might very well be the beginning of a prolonged period of weakness – albeit with some sharp rallies along the way. I still expect a range bound market, but that range could extend downward quite a bit. Accordingly, it might behoove investors to be cautious and reduce market exposure. Even though it is always a good idea to buy undervalued quality stocks on weakness, now is perhaps also the time to be much quicker to sell on strength. This was the nimbleness that I referred to last month, and it can be instrumental in allowing investors to bypass a good portion of market declines while still being able to participate somewhat in market rallies.
 
Michael H. Berlin, CFA, CPA, is the founder and portfolio manager of MHB Equity Partners, a value-oriented private investment partnership. He previously worked at Lehman Brothers, and before that at Ernst & Young. Mr. Berlin holds an MBA from Columbia and a BBA from Michigan.
 
The information included in this article is not intended to be used as a basis for making investment decisions nor should it be constructed as a recommendation to buy or sell any specific security. Consult your investment professional for additional information and guidance.
 
 Michael can be contacted at mberlin@mhbpartners.com and at (631) 629-4928.