Trader’s Narrative

Book Giveaway
If you haven’t already, throw your name into the hat for a giveaway of:
Hedge Fund Operational Due Diligence (follow link and submit comment)

Jeremy Grantham, Chairman of Grantham Mayo Van Otterloo, is one of the few that saw the financial crisis coming. In 2007 he wrote, warning that we were caught in “The First Truly Global Bubble“. There was only one asset class that liked back then, and even that didn’t fully escape unscathed.

But Grantham isn’t a perma-bear. Since the brutal bear market, his views have changed completely. Here’s a preview of his newest letter to GMO clients:

In his letter, written before last week’s gains, he says that the market is fully valued at appx. the 900 level:

For the record, we now believe the S&P is worth 900 at fair value or 30% above today’s price. Global equities are even cheaper. (Our estimates of current value are based on the assumption of normal P/Es being applied to normal profit margins.) Our 7-year estimated returns for the various equity categories are in the +10 to +13% range after inflation based on an assumption of a 7-year move from today’s environment back to normal conditions. This compares to a year ago when they were all negative!

Then he discusses briefly how GMO is handling the dilemma of either moving too early, and having to endure further losses, or moving too late and giving up gains as the market moves up:

… you absolutely must have a battle plan for reinvestment and stick to it. Since every action must overcome paralysis, what I recommend is a few large steps, not many small ones. A single giant step at the low would be nice, but without holding a signed contract with the devil, several big moves would be safer.This is what we have been doing at GMO. We made one very large reinvestment move in October, taking us to about half way between neutral and minimum equities, and we have a schedule for further moves contingent on future market declines.

Of course, he is an institutional investor, having to position billions of assets. But the lesson is the same no matter the size of your account. You must have a battle plan laid out before hand so that when the market reveals itself, you know exactly what to do and aren’t caught off guard.

You can read the whole March 2009 letter from GMO in the Free Trading Resource section - in the Reports & Articles folder, where you’ll also find other interesting reports, articles and even complete trading books.

The two major groups in the stock market have been and will always continue to be large, well capitalized and well informed “insiders”; and the small, underfunded, emotional, ignorant retail investors and traders.

These two groups engage in a financial dance which invariably concludes in the long term with one group enriching the second. Although they usually don’t take such contrasting positions, at times they can mirror each other.

A good example was in 2000 at the top of the internet bubble. The knowledgeable, “insider” team made up of hedge funds, investment banks, other Wall St. operators and the private equity team sold bits of paper (shares) in exchange for money from the retail crowd.

Right now we are seeing another one of those times. But this time it is the “insider” team that is on a buying spree.

Commitment of Traders
I’ve already mentioned that the commercials were crazy long equity futures contracts and although some time has passed things have not changed. The commercials are long about $38 billion worth of contracts while the small speculators are long their smallest amount since the bottom of the bear market.

Fund flows
According to fund flows data estimates, as the retail investor is fleeing the equity markets and seeking the sanctuary of bond markets and money market funds, the institutional investor is buying with the same intensity. Watch video about half way on the link.

Insider Activity
Corporate executives and other insiders are probably the most knowledgeable about a company’s future and while the market has taken a tumble, they haven’t been spooked. On the contrary, their buying here is only equaled to that seen at the bottom of the bear market. This in contrast to the retail investor who has been buying anything but US equities.

Newsletter Market Timers
The best market timers among the newsletters are wildly bullish, with an equity allocation of 92%. Meanwhile the worst are out of the market completely with a 0% allocation.
Credit: Mark Hulbert in Barron’s