Current Equity Market Performance

I had a long meeting with my partner this week, and the topic of our portfolio strategy's performance arose. The strategy now trails the index by some 10 percentage points.

Earlier in the year, I was more perplexed and concerned by the portfolio's lackluster performance relative to the index. Now, however, it's clearer to me what is occurring.

Beginning with May's negative index return, the first this year, and continuing with a nearly equal performance so far in June, the S&P is now hovering at a 0% return for the year. Evidently, many investors have become so paralyzed and confused by various confusing signals regarding global economic activity and US inflation, that they are just treading water. They feel no compelling directional push from the mass of data.

As my partner and I discussed this, he asked if it were not true that, essentially, our position is, "we are right, and the market will come around sooner or later." Is this not rather arrogant, he thought? "Arrogant" may not have been the word he used- but his point was similar. Are we not "blaming" the market for our being behind, and accusing other investors of "getting it wrong" on equity valuations.

This led me to another application of my insight on mediocrity. If you search this blog for the term "mediocrity," or "mediocre," you will find several past blog posts which explain my thoughts on this important concept.

In the equity market, I believe that the vast preponderance of investors, institutional included, are mediocre, and, at times such as these, spend most of their energy being scared, trading aimlessly, and generally emitting no directional signal whatsoever.

We have a lot of apparently mixed signals in the market right now, if you aren't very savvy. There is the bugaboo of high energy prices. Then there's the Mideast situation overlay- Iran, Iraq, and even Nigerian supply issues. Commodity prices have been high, gold rose, and, in the US, the Fed is worried about the current rate of inflation.

Yet, US corporate performance is good, and commodity prices and demand signal continued healthy global growth.

My contention is that the "average" investor is now like a deer caught in the headlights of an oncoming car. S/he is frozen.

Taking a look at my portfolio selection process' recent results, I am struck by the continued significant presence of energy companies. Homebuilding fueled the portfolio's outstanding performance for some 18 months over the past two years. As the sector cooled, though, the companies in the sector that had been selected for the portfolio were gradually dropped by the process. Not so with energy. Something else is going on here. Despite this year's choppy return performance by many energy companies, they remain prominent in the model's selections.

My thinking is that this represents the system's reaction to a strong, if confusing, equity market situation. The portfolio strategy does worst with a near-zero index return. In times like these, growth equities are punished, but not so emphatically, for so long, as to justify shorting them.

Instead, we are in the position of remaining long prior to what I believe will be an awareness on the part of many market investors, later this year, that things are really quite attractive and healthy in the equity markets. Since our model is designed to be invested, and not in cash, we are now long, and, thus, behind a wavering market.

The recent occurrence of days of sharp gains and losses by the index and the portfolio, some approaching 4% daily, suggest to me that we are near a "bottom" of uncertainty-related trading. I expect that by summer's end, either the market will plunge, and our strategy will go short, or investors will realize that there is healthy fundamental global economic growth, and the equity market will advance sharply for several months.