I wrote an article for Money Morning on Tuesday entitled: "The Great Rotation Makes Stocks a Generational Buy."
The story drew several comments from readers - some in agreement, others... not so much.
For instance, reader Mike W. wrote in quoting the article:
"Last week $22 billion flowed into mutual funds and ETFs. That's the second-largest weekly flow on record. Of that... $8.9 billion flowed into equity mutual funds... the most since March 2000 and the fourth-largest weekly inflow on record."
"What happened after the [largest] inflow of $23 billion in late 2007? The stock market fell off a cliff. What happened after March of 2000? The stock market fell off a cliff."
As you might have guessed, there's much more to this story...
The Problem with "falling off the cliff"
The problem is, Mike's not comparing apples to apples. What's more, I'm not advocating buying blindly.
Instead, I point out that buying these days should include global diversification, asset class diversification, and buying downside protection. Downside protection alone comes in umpteen different flavors, all thanks to ETFs.
The problem with the "falling-off-the-cliff" argument is that it compares three different time periods and points to what seems to bea common factor. That is to say, the markets did collapse after each of the historical inflows he mentions.
But Mike is right in a very real sense. Too often the public jumps into great bull markets at exactly the wrong time. Contrarians actually use their arrival at the party en masse as a signal to get out of the house because the music's about to stop.
Back in 2000, the hot money was chasing Internet stocks in a feeding frenzy; there was a new billionaire every minute. Stocks without earnings were doubling - doubling - every month or so in a textbook case of irrational exuberance. There's a better word for it: craziness.
Then came the blow-off from the reality check - along with the realization that hot-shot star analysts were aiding and abetting one of the biggest pump and dump schemes in history. This sent the latecomers off the cliff and upset the apple cart for just about everyone.
The markets came roaring back in a few years. In 2007 the real estate bubble was about to burst.
Again, the latecomers, those perennial Tail-End Charlies, were the tragic actors. Most of them were making money - on paper - and borrowing against their (unrealized) real estate gains. They chased the markets and, wouldn't you know it, stocks were the end destination. They all piled in, just ahead of the inevitable cliff. We all remember what happened next.
It's important to note that the market crash was the result of the real estate crash and all that leverage that had built up everywhere. There were margin calls all over the place and people were selling everything to get out of the way. Everyone was headed for the exits while the hedgers and short-sellers sold like their lives depended on it.
When it was all over, what happened?...
We went over the cliff and came back around to the edge again - with one very important difference. This time around we're looking at a lot less leverage in the system and no major retail bubble to push us over.
This time, stocks have not risen as a result of bubble-making gamblers throwing money into ridiculously over-pumped companies. There is a bubble-making gambler at work here, to be sure, but that's the Fed in all of its quantitative-easing, easy-money, double-fisted, hand-pumping glory.
Corporations are not where they were in 2000 -- or 2007. They are infinitely better off now.
But there is another side, should the Fed slow down its pumping operations. Interest rates will start to rise and bond prices will start to fall.
The Great Rotation Game Plan
That's going to be one of the triggers of the Great Rotation. So, it can be argued that the Fed-pumped markets may be in danger of falling if the Fed stops pumping. But that will mean the money flows into stocks.
The picture I'm painting is this: there will be trillions of dollars coming out of low-yielding bonds. That money needs a place to go, and the destination is the stock market. It will be the beneficiary of the Great Rotation as the money flows in, looking for return, dividend yield and appreciation.
I'm not saying we won't see a correction; we're way overdue for one. We could see increasing volatility in the first two quarters of 2013.
But still, I'm looking for buying opportunities, especially on the dips. If we get a correction, a particularly big one (which I'm really hoping for), I'm diving in with everything I've got - right when it looks the worst.
Why am I hoping for a steep correction in the first half of the year? So I can buy the panic with both hands and reap the rewards from the bounce and massive push that's sure to follow the wholesale dumping of bonds at their last gasp.
If we don't get a correction, I'm not going to sit by and watch the market double and say, "I'm gonna get in on the next correction!"
No, I'll get in now and add on the way up, raising my stops the whole way. That way, I'll stop out if there is a big correction, with profits or without, and I'll keep buying at lower prices if we go there.
That, my friends, is why we're at a generational buying point. Besides, I'm always buying insurance so I can sleep at night.
Sitting out this building move is the greatest the investment mistake you'll ever make.
Editor's Note: For more about The Great Rotation, and to join the conversation with Shah, click here.
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