Is the market acting rationally?
That’s the first question advisors should be asking themselves. With all the uncertainty in the economy, and a Congress that doesn’t seem willing to face our myriad problems, I think the answer is “Yes.”
Yes, stocks should have dropped Thursday. But at some point, the selloff will become irrational. And in my opinion, that is the point of maximum opportunity.
There are several signs to look out for. First off, T-bills traded with a negative yield Thursday morning. That makes no sense, and signals that market participants will do anything to cut the risk in their portfolios.
I also like to gauge sentiment by looking at the discounts in closed-end funds (CEFs). The best online tool is www.cefconnect.com, where users can sort by type of fund, the size of the discount to NAV, and the yield.
Some of the more interesting opportunities are in the equity space. Eaton Vance Tax Advantaged Global Dividend Opportunity Fund (ETO), for example, is trading at a 9.4% discount to net asset value and sports a 6.9% yield. In essence, one is able to buy a basket of stocks for almost 10% less than the cost of acquiring them in the open market. CEF discounts aren’t quite large enough to pounce on, but should certainly be on advisors’ watch lists.
If the market rout continues, stocks may eventually price in a double-dip recession. There are no economic factors pointing to economic decline, although it is obvious that growth is much slower than expected. If one assumes that the natural direction of the economy is to grow over time, it is much more prudent (and easier) to be discerning at market bottoms than to attempt timing market tops.
The doom and gloom from last summer’s swoon resulted in a 16% pullback for the S&P 500 index. At current levels we are about 10% lower than the highs reached on April 29. I will be watching the markets closely in the next few weeks, and will share our views on an active basis.