t’s time to Sell… an Update
In our last general update (published in mid-February) we opened with this line, “It’s time to sell… not indiscriminately, and certainly not in a panic, but it is time to selectively reduce risk by taking profits in securities…” So, what has happened since that time? Quantitatively, not much. Despite some significant daily gyrations, the S&P 500 is little changed overall, down roughly 1% from the time of our February article to today, July 2nd. For our client accounts we have executed our views by selectively taking profits and allowing cash to build. In our flagship Palmetto Growth & Income Strategy we have increased our cash holdings to an average of 18%, up from approximately 8% at the time of our February blog. We are comfortable that we have been generally correct on market direction and we like our positioning as we enter the second half of 2015.
So What’s Next?
We believe this year’s lackluster market reinforces our strategic direction. With the S&P 500 already trading at roughly 18X current year earnings there are really only two catalysts we see that can drive the market to further gains at this point:
1) Earnings growth – Corporate profitability must grow in order to justify higher stock prices. Earnings season begins later this month and we will get a view as to whether that is happening.
2) Multiple expansion – People are willing to pay higher prices for the same earnings (higher multiple of earnings).
In our view, neither is very likely in the near term. With that as a backdrop, let me attempt to tie-in our current invest philosophy with the article’s title and the Independence Day holiday weekend.
In June, 1775, roughly 1,000 American soldiers gathered at Cambridge and then departed with a wagon full of entrenching tools. The Battle of Bunker Hill would follow the next day. The Americans did not complete their fortifications before the sun rose. At daybreak, the British began bombarding them even as they tried to finish their work. The Red Coats marched on the American position, while the Americans, conscious of their limited supply of ammunition, were told not to fire upon the British until they were extremely close. They were told: “Don’t one of you fire until you see the whites of their eyes!” When the first barrage of American musket fire finally came it took down many, many British soldiers. The British attempted a second attack on the hill, but with the same result. The third attack went better for the British, partly because they had reorganized and partly because the Americans were running out of powder.
Technically the British had won, but it was a costly defeat. More than 1,000 British soldiers were killed or wounded while the American losses were much smaller at about 400 men killed or wounded. American General Nathanael Greene wrote: “I wish [we] could Sell them another Hill at the same Price”! Meanwhile, British General William Howe later said: “The success is too dearly bought.” As we know, the struggle led to the signing of the Declaration of Independence the following year in 1776 and ultimately to American Independence.
“Don’t Fire Until You See the Whites of Their Eyes!”
Essentially, we have adopted the same approach. We see little reason to chase the market higher given its current valuation. Our view is that it is wise to continue to conserve our capital (reference American ammunition). Rather than firing at distant targets, we will wait for the market (the Red Coats) to come to us ensuring a higher probability of success. As a reminder, we have had six consecutive years of market gains making this Bull Market pretty long in the tooth. While not ready to sound the death knell for the Bull Market just yet, we do see the probability of correction of 7% or more as at least equal to, if not greater than the probability of further significant market upside. As I type, the market is essentially flat for the year (+0.7% on the S&P 500, – 0.6% for the DJIA). It would certainly not surprise us to see the market finish in the red for the year, and if that is the case we want to be positioned to protect our clients and have “dry powder” available to take advantage of the lower pricing. Like the early Patriots, we’ll hold our fire until we see the whites of their eyes!
Happy Independence Day to all and may God continue to bless our country.
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