This is a common saying on Wall Street. It seems simple enough but actually it means different things to different investors. From the highly mathematical (today’s price equals future discounted cash flows) to the gut feeling that we take with us shopping (this looks cheap/expensive). Almost all financial research is deployed to determining the correct or intrinsic value of an asset. That calculated “intrinsic” value is then compared to the current market price. Either the current price is cheaper than our calculated value, about the same or more expensive. From there, come the Buy, Hold and Sell recommendations from the research department.

In a perfect world, that should be the end of the process. The difference between the market price and the intrinsic value represents the time value of money plus a risk premium. There are several schools of valuation so a market should be able to exist as adherents place bets on the accuracy of their respective research efforts.

Unfortunately, the world is far from perfect and final prices are actually determined by two emotions: Fear and Greed.

So, as investors, how do we deal with this situation? How can we remove the emotions of Fear and Greed which end up costing us money? We work from the slightly different starting point that prices contain information. Do they contain perfect information? Sadly, no. But, as we move forward in time, changes in price certainly can tell us about changes in the market’s perception of value.

In practice, this sets up three price trend conditions which can be described as :

“Climbing the Wall of Worry”

This is how most investors describe a bull market and it is a money maker. We should be willing to trade our cash (a very safe but low yielding asset) for an asset that is “climbing the wall of worry”. But we need to remove the Fear emotions that hold us back from making the investment. We also need signals to tell us when the trend has changed to one of the other two conditions. Identifying a positive price trend can address both of these concerns. As long as the price trend is strongly positive, we can participate. When that trend fails, it is time to switch horses.

“Sliding down the Slope of Justifications”

This condition is also known as a bear market. When prices are falling, we tell ourselves that the investment will come good despite the evidence of the negative price trend. It is a money loser. In these circumstances, we should trade the investment in for cash or an asset that is in a rising trend.

And, “Bouncing around Trendlessly”

This third condition is also a money loser because opportunities are missed while our investments fail to grow. We should look to trade a trendless and risky investment for one that is in an uptrend or, if we cannot find an upward trending investment, we should trade it for a low yielding but non-risky asset like cash.

So where are we now?

Unfortunately, we have been moving from “Climbing the Wall of Worry” to “Bouncing around Trendlessly” since the beginning of the year. The trends of all the asset classes we track have been weakening steadily over the past three months as fund flows have remained largely static.

Will we return to the “Wall of Worry”? There is certainly plenty to worry about. Interest rates are extremely low and given the fiscal situation in the US and Europe, they are very likely to rise. Growth in the US has been pushed forward by a combination of government spending and inventory restocking, not consumption and/or business investment. Europe is trying to come to terms with a strong, competitive Germany in the middle of a monetary union that includes many weak, uncompetitive players around the edges. In the emerging markets, the BRICs countries (Brazil, Russia, India and China) are still posting above average growth but there are signs of overheating in China which may have global repercussions.

In our global portfolios, we see strength in Emerging Europe (GUR, with Russia RSX looking stronger than Turkey TUR), Biotech (XBI, and Medical Devices, IHI, in the US) on the back of ObamaCare, India (EPI), High Yield (HYG, most of the bad news is in the price) and Japan (EWJ, a perennial laggard).

Are any markets ready for a slide?

Our models are showing some movement out of Asia and into the US in general and the US dollar (UUP) specifically. If interest rates rise in the US, we would expect to see more funds flowing to take advantage of the higher yields. In our Asian Long/Short Portfolio, shorting Hong Kong has moved into the 4th slot. With cost of office space running triple the rate of Singapore, Hong Kong looks frothy. The Hang Seng has bounced around 1500 points to either side of the 21,000 mark for the last seven months so, at the very least, it qualifies as trendless. If interest rates rise in the US but are held down to protect the property market in Hong Kong, we could see a large liquidity drain as hedge funds set up an HK$/US$ carry trade. That would not bode well for equity prices in the Fragrant Harbor (EWH). If interest rates are allowed to rise with the US rates via the peg, the frothy property market becomes vulnerable to a correction.


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