Great March, Crummy Quarter, but better times ahead

True to it’s name, March came in like a lion and went out like a lamb. After continuing its recent tumble that began in early January, the MSCI ACWI (All-Country World Index) hit a bear market low on March 9 that was –58.4% below the all-time high set on Oct. 31, 2007. The magnitude of the drop makes this the most severe bear market since 1932. At its low, stocks were as cheap by most measures as they have ever been (as I discussed in a prior email). If the March 9 level holds (and it’s looking increasingly likely to me that it will), then it could well mark the low point for stocks in the 21st century.

Then, on March 10, global stock markets embarked on their most powerful rally since 1938, rising +22.6% in only 12 trading days before settling back a bit (although as of today’s close, we’re back up to the March highs). For the month of March, the MSCI ACWI rose +8.2%, reducing its loss for the first quarter to –10.7%. This was clearly crummy, but still better than the stunning loss of –22.4% during the 4th quarter of 2008.

So where do we go from here? Have stocks really hit their lows for this cycle? Is it finally time to start buying again? Obviously, I wish I knew for sure. And although I don’t, the character of this rally makes me feel like it is finally the real thing, a rally that will eventually (over 4 or 5 years) take stocks to new highs. My reasons are many, and include: 1) fundamental factors, such as the extremely low valuations seen on March 9; 2) technical factors, such as the divergence between the level of stock indexes during the decline and the number of stocks hitting new lows, and decreasing volume on down days with increasing volume on up days; 3) sentiment, which is still very low despite the rally, with most investors doubting its staying power and believing that even lower lows lay ahead; and 4) economic factors, which suggest that the rate of economic decline is slowing, and that an end to this recession may finally be in sight.

This rally, if I am right, is likely to humble both the bulls and the bears. The bulls will be humbled because real bull market rallies move upward in fits and starts, with many scary drops (such as the one we saw on Monday) that make one question the rally and potentially sell out prematurely. Countertrend rallies, on the other hand, tend to move almost straight up, rekindling a false optimism among investors. Bears will be humbled because in waiting in vain for those lower lows, they will miss out on a big portion of the rise, not investing until it’s clear that the prior lows are but a distant memory. Most investors will not, as they mistakenly believe, get back in at a level lower than that at which they sold. More likely, they won’t reinvest until stocks are some 20% to 40% higher than their exit points.

For those who might be concerned, I definitely don’t think it’s too late to load up on stocks. Based on yesterday’s close, and a historical average of 5 years for stocks to return to prior highs, one could reasonably expect an average annual return of around 17% per year through 2014. Certainly not bad, and significantly better than most competing investments. (Obviously, this is a projection, not a guarantee.)

Thus, if we’re really past the worst of this epoch-making bear market, and it’s not too late to fully invest in equities, it makes sense to re-allocate portfolios. Toward this end, I now plan to start re-allocating portfolios to prepare for the next phase of the economic cycle. This process should take about 2 months. During that time, I will be writing a series of emails explaining: 1) my portfolio construction process; 2) my short-term and long-term expectations for the global economy, corporate earnings and asset valuations; 3) my specific rationale for stock, bond, country and industry allocations; and 4) my choice of specific securities and the reasons for those choices.

I will also be contacting each of you individually to discuss your personal portfolio recommendations, which will be customized within the broader parameters to be outlined in the emails. More than ever before, it’s crucial that we’re each on the same page going forward, as the future is even more unknowable than usual.

Here’s to a brighter future