Investors love to ask this question. You’ve got an investment idea. You run through the fundamentals, the technicals, sentiment, macro, insider buying/selling and more. It all makes sense but it doesn’t matter until there’s a “catalyst.”
The catalyst is the thing, news event, the discovery, the company announcement, the takeover, etc. that gets the stock moving. It’s the thing that gets Mr. Market to sit up and take notice.
I turned bearish about a month ago and ever since I’ve been asking myself this question: What will halt stocks’ advance? What’s the bearish catalyst?
The problem is this question doesn’t really matter because it can’t be answered. And you don’t need to answer it to make money in the markets. To make money in the markets you simply have to find a way to put the odds in your favor. To answer this question, however, you have to be able to predict the future.
Who would have guessed a month ago that Cyprus would be blamed for this selloff (if it can even be called that)? Nobody. In fact, Cyprus probably wasn’t even the reason stocks sold off. It could be that investors are just looking for any old excuse to take profits right now.
It’s true that all the research in the world doesn’t matter until there is a catalyst but don’t let the fact that you can’t predict what it will be prevent you from doing your thing. If you’ve got a trade or investment idea based on a sound methodology you don’t need to worry about a catalyst even if it is fun to speculate about it.
Besides, can you ever really prove what specifically moved a stock or the market on any given day? It could be that news story that sent it soaring or crashing or it could just be short-covering or panic selling or the January effect or tax-loss selling or a million different things. Who the hell really knows?
In the end, the catalyst is just a means for traders to make sense out of a change in trend.
Yesterday, Dr. Copper fell out of bed (which could have also been the catalyst for stocks selling off or stocks could have been the catalyst for it, who knows). It broke down out of a massive pennant:
If the economy, led by housing, is doing so well why is Dr. Copper performing so poorly? This is a major disconnect and the divergence between the two just keeps getting wider:
The rubber band looks to be stretched near its breaking point right about now so don’t be surprised to see some sort of snapback – I expect we will see stocks selloff (for real) or copper rally or some combination of the two really soon.
Turning to valuations I was intrigued to read the Sequoia Fund’s Annual Letter the other day. For those unaware of these guys, had you invested $10,000 back in the fund at its inception back in 1970 it would be almost $3 million today. With track record like that they deserve your attention. Here are a few key quotes from the letter that stuck with me:
In the fourth quarter of 2012, we were modest net sellers of equities for the first time since 2008… Given the huge run up in equities since early 2009, we are no longer finding compelling valuations, either for our existing holdings or for new ideas we are researching.
Translation: ‘This bull market is getting long in the tooth. Not only have we stopped buying, we have started selling or reducing exposure to it.
Valuations for stocks are heavily influenced by interest rates, and particularly by the risk-free rate of return on 10-year and 30-year United States Treasury bonds. Relative to the current return on Treasury Bonds, stocks continue to be quite attractive. However, the current risk-free rate of return is not a product of market forces. Rather, it is an instrument of Federal Reserve policy. As long as these policies remain in place, and stocks trade at higher levels of valuation, it will be more difficult for us to find individual stocks that meet our criteria for returns on a risk basis that incorporates substantially higher interest rates than exist currently. Just as we think it would be a mistake for investors to buy bonds at current levels, we believe it would be a mistake for us to buy stocks on the assumption that interest rates remain anywhere near current levels.
Translation: ‘The game has changed. Due to the Fed’s activities over the past few years, we have entered brand new territory in the stock and bond markets. Buying stocks today is purely a vote of confidence in the Fed’s willingness and ability to keep asset prices aloft. It may very well turn out that this confidence is misplaced.’
This “confidence game,” as I’ve called it, is a topic I’ve spent a good deal of time on over the past few months. Still, as Alan Greenspan recently noted, we’re probably not currently experiencing “irrational exuberance” to the degree we have seen in the past so stocks can continue to go higher. But “irrational confidence” is enough for me to make like Sequoia and leaf the markets to an extent.
The catalyst for an end to this bull market could be the “sell in May” phenomenon, a new recession or Kim Kardashian giving birth to Kanye’s baby. I truly have no idea but it matters very little to my way of thinking.