We made a new high today. (yay!) What does it mean for the future direction of stock prices? If you're an optimist it means that there are clear skies ahead and there's no telling how much higher this market will go. Pedal to the metal with your equity exposure.
If you're a pessimist it means that this is the start of the final blow-off top. When this melt-up runs out of gas, Katie bar the door.
But if you're a realist, you probably see today's new high as just another indication that the market has gotten ahead of itself. Realists will wait and watch as more data comes in about the economy and how far policy makers are willing to go to keep this house of cards from crumbling.
The Market Melt-Up
I've been saying for months that we could get a melt-up in the market, from a trade deal with China and Mexico, or a rate cut by the Fed. Well, we finally have the perfect conditions for a market melt-up. The market is at an all-time high, and the fed seems to be open to a rate cut. What could go wrong?
For one thing, the market is a forward-looking indicator. The market is dominated by large institutional investors and ultra-high net worth individual investors. And these dominant players appear to be on-board with the idea that China will cave to Trump, and Mexico will do the same.
They further believe that the Fed will cut rates and by doing so will place a bid under the market. In my view, lots of things would have to go right to make the optimistic case come to fruition. It could happen, but I'm skeptical.
I prefer to remain 65% long equities, 15% short equities, and 35% in cash. (That doesn't add up to 100% because I'm using margin debt to finance my short position.)
As the economy continues to soften and the market continues to move higher, there is a rare opportunity to make a contrarian bet by buying SH (the short S&P 500 ETF).
If you're an optimist you shouldn't do this. You should go all-in with your equity exposure to take maximum advantage of the melt-up. There is nothing written in stone that says my defensive posture will produce a better outcome than an aggressive one.
Mean Reversion
Whatever you decide to do, don't forget the Golden Rule of mean reversion. We have been enjoying 15% annual returns since the last market bottom 10 years ago. But the market ALWAYS reverts to the mean return of 9.5%.
What that means is that it will take a decline of at least 60% from where we are today, just to return us to the long-term mean of equity returns.
Ask yourself this question. Are you willing to bet your life savings on a game that has a 10% upside and a 60% downside?
If you're a realist the answer is a resounding no. If you're an optimist your answer might be yes! Happy days are here again!