Advice from a Bear: Wait it Out

11/10/2011 7:00 am EST

Focus: MARKETS

Current levels of debt, along with macro uncertainty, keep Paul Lamont on the sidelines, he tells MoneyShow.com. High levels of market correlation make stock-picking a risky proposition, and he advises retail investors to get into cash and just wait for overall conditions to improve.

Kate Stalter: Today the Daily Guru guest is Paul Lamont. He’s the founder of Lamont Trading Advisors, as well as publisher of Investment Analysis Report.

Paul, you use historical research, behavioral analysis, and technicals to guide investment decisions for your clients. So give us a little background on your methodology, and what that’s showing you in terms of investment ideas in today’s market.

Paul Lamont: Sure. We use a historical perspective, we use a technical measure for the market sentiment, and like you said, behavioral investing.

Currently, we’re very bearish on the market. We’re just trying to protect what we have. Basically, we position ourselves as we did in previous cycles and, yes, protect the investor for right now.

Kate Stalter: Tell me a little more about some of these indicators you’re using, and maybe some of the red flags that are jumping out at you these days.

Paul Lamont: For instance, we use the Daily Sentiment Index, which is Jake Bernstein’s survey of futures trading. Not to get too technical, but it basically measures how hot or cold the futures pits are. Earlier this spring, they were extremely hot. In fact, more optimistic than they were at the top in 2007.

So obviously we’ve had a sell-off this summer, and they got bearish at our October lows. Once again, they’re getting warmer, and we’re concerned with another rollover here. That’s why we’re looking lower.

Kate Stalter: So, looking at some of the most popular newsletters that you have on your Web site, that dovetails nicely with what you just said. You have made a number of market calls in the past few years that did turn out to be spot on, pertaining to market direction or other developments. So what does that history show you, that could be some kind of warning signal these days?

Paul Lamont: Well, obviously in our current environment, with as much debt and leverage that’s in the system, that lends itself to a lot of instability and volatility.

So any time we have the high measures of optimism and basically declining momentum in the stock market, we get very nervous and we basically rein our horns in, and that obviously would be to raise cash.

Kate Stalter: Tell me a little bit about the balance between evaluating some of these macro conditions, while also looking at good performance in specific sectors or individual stocks. We’ve seen some areas that have remained solid performers even in these uncertain macro conditions. How do you make investment decisions for your clients in that scenario?

Paul Lamont: We have a top-down approach. We start with the macro.

There may be stock pickers that can perform very well in this environment. For instance, in the sell-off in August, all 500 of the S&P 500 stocks were down that day. Now obviously that’s just one day, but when you have this kind of correlated trading between stocks, we think it’s very hard to be able to pick those stocks out.

We are basically on the sidelines because of that—because of the correlation between the markets, and how everything is essentially trading on credit and optimism and pessimism.

Kate Stalter: What would be some signals that you’re looking for that might change your market outlook?

Paul Lamont: Well, we would love to see more bearishness. That would obviously give us more confidence in waiting out the markets.

Also, the amount of leverage right now that’s in the system. Margin accounts were actually higher than before Lehman Brothers failed. So we obviously look at margin debt on the New York Stock Exchange.

So we’d like to see a lot less risk-taking and a lot lower debt in the system, which obviously kind of implies lower prices.

Kate Stalter: Let me ask you one final question today, Paul. What advice would you have for individual investors, maybe the do-it-yourself investors who are at home, listening to this? What’s the best way for them to protect themselves right now?

Paul Lamont: Well, I would say don’t be afraid to just wait it out.

I think if you read Bridgewater Associates’ Ray Dalio, who is the hedge fund’s manager, he essentially talks about how we’re in a period of a credit bubble unwind. During that period, people who are very leveraged have to sell assets. So if you’re just waiting on the sidelines, these prices are going to come down.

Now obviously, the government is trying all it can do to kind of prop this thing up, and continue basically kicking the can down the road. But for the patient, long-term investor, we actually think that just sitting on the sidelines and waiting to see how all these debt problems play out is a wiser strategy than actually to be involved in the market.

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