Monday, June 14, 2010

Sucker's Rally?

It's been awhile since my last post, so I apologize to my regular readers - I think there are 2 of you :)

Last week I read a fascinating article in the Huffington Post, entitled "Remember: In 1930, They Didn't Known It Was 'the Great Depression' Yet" (http://www.huffingtonpost.com/henry-blodget/remember-in-1930-they-did_b_605814.html). I highly recommend reading it in its entirety, but the basic gist is after the 1929 crash there was brief period defined by renewed optimism, speculation, IPO's, etc. which of course turned out to be a sucker's rally.

Basically, the market went from its 1929 peak of 381 to an initial bottom of 199. This was followed by a rally that pulled the market all the way to 294 over the next six months. Finally, after this "sucker's rally" the market once again turned negative and bottomed out at 42 eight months later (that's right, 42!).

The point of the article is to draw similarities between what's unfolding today and what happened back then - was it a sucker's rally when the DOW went from its March 2009 low of 6.5K to its May 2010 high of 11.2K? Should we expect the market to hit new lows over the coming months and years?

Obviously I have no clue.

Interestingly enough, George Soros recently gave a speech in which he elaborated on this very subject (http://www.gurufocus.com/forum/read.php?1,97265,97464#msg-97464). During this speech, he said such warm and fussy things like:
  • The current situation in the world economy is “eerily” reminiscent of the 1930's with governments under pressure to narrow their budget deficits at a time when the economic recovery is weak.
  • “The collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama.” (Act I is defined by replacing private debt with public debt, "thereby reinforce[ing] the excess credit and leverage that had caused the crisis in the first place." Act II began "when financial markets started losing confidence in the credibility of sovereign debt," with Greece and the Euro taking center stage.

So if the bear case I described above does indeed come to pass it could mean very bad news for the average Joe who invests in common stocks (i.e. me). The question is how should one position their portfolio if they believe there's a 10% chance it'll play out (or 25%, or 5%, etc.)? Remember, there's always a chance that we make it through this mess unscathed, and if you hold too much cash you could miss out on significant upside...

Personally, I've got about a third of my portfolio in cash. Not only does this act as a safety blanket should things head south, but it will also give me the opportunity to snatch up some bargains in this scenario. Conversely, the other 2/3rds of my portfolio is spread over a small handful of stocks that I feel are undervalued in aggregate, so should the market rally I feel these securities will do quite well.