All Things Bearish

For a relative investor (following the edicts of value investing), we believe the choice is clear: Own as much international and emerging market equity as you can, and as little US equity as you can. If you must own US equities, we believe Quality is very attractive relative to the market. While Quality has done well versus the US market, long international and emerging versus the US has been a painful position for the last few years, but it couldn’t be any other way. Valuation attractiveness is generally created by underperformance (in absolute and/or relative terms). As Keynes long ago noted, a valuation-driven investor is likely seen as “eccentric, unconventional, and rash in the eyes of average opinion.” [Emphasis mine.]

In absolute terms, the opportunity set is extremely challenging. However, when assets are priced for perfection as they currently are, it takes very little disappointment to lead to significant shifts in the pricing of assets. Hence our advice (and positioning) is to hold significant amounts of dry powder, recalling the immortal advice of Winnie-the-Pooh, “Never underestimate the value of doing nothing” or, if you prefer, remember – when there is nothing to do, do nothing.

Markets appear to be governed by complacency at the current juncture. Indeed, looking at the options market, it is possible to imply the expected probability of a significant decline in asset prices. According to the Minneapolis Federal Reserve, the probability of a 25% or greater decline in US equity prices occurring over the next 12 months implied in the options market is only around 10% (see Exhibit 12). Now we have no idea what the true likelihood of such an event is, but when faced with the third most expensive US market in history, we would suggest that 10% seems very low.

Those are wise words indeed.

Colorado, Chicago, Lisbon, Denver, and Lugano
I don’t feel as though I’ve traveled that much this year, but my American Airlines AAdvantage account says I’ve flown 122,000 miles so far. I will be traveling a great deal more between now and Christmas. Late next week Shane and I will go to Colorado for four days at Beaver Creek and then spend four days in Denver for a little R&R before the serious work begins this fall. Late in September I will be in Chicago for two days for a speech, fly out the next day for Lisbon, and return to Dallas to speak at the Dallas Money Show on October 5–6.

I will be speaking at an alternative investments conference in Denver October 23–24 (details in future letters). I will again be in Denver November 6 and 7, speaking for the CFA Society and holding meetings. After a lot of small back-and-forth flights in November, I’ll end up in Lugano, Switzerland right before Thanksgiving. Busy times.

It is time to hit the send button. You have a great week!

John Mauldin is editor of Mauldin Economics' Outside The Box.

This article was originally published at Mauldin Economics.