The first half of 2014 is almost over, and it certainly came with a lot of surprises. Here are just a few.
First, while the market hardly reacted, the first-quarter GDP numbers were abysmal, with gross domestic product declining 2.9 percent despite the fact that the economy was supposedly improving to the point where we were less dependent on Federal Reserve stimulus.
Second, the stock market didn’t live up to expectations. The strong gains we saw in 2013 got people’s hopes up, and while stocks rallied in the first half, the gains were small. Furthermore, the market favorites (i.e., the high-growth stocks that led the market higher in 2013) underperformed.
Third, safe haven assets performed extremely well. The three I have in mind include long-term Treasuries, gold, and utility stocks. Each of these groups, especially the first two, were hated by the market last year, and yet they each delivered double-digit returns.
Given these points, it is clear that the optimism with which we began 2014 has started to dissipate. However, it is largely still in place, and as a contrarian investor, I am concerned. Economists have unanimously written off the weak GDP data as a onetime event, and they believe that we will quickly rebound in the following quarters.
Furthermore, stock returns are supposed to resume to “normal” later this year, with normal being strong double-digit returns for the major averages and even greater returns for growth stocks. This stock price appreciation will be driven by earnings growth — which largely disappointed in the first half — which follows from the strong economy that we are supposed to have.
While we may not see a sharp decline in GDP or in the stock market in the second half, it is clear that analysts and investors have a positive bias that doesn’t mesh with the weakness we saw in the first half. This doesn’t bode well for stocks. We have to keep in mind that the best environment in which to own stocks is one in which stock ownership is a scary proposition.
Recall that the best buying opportunity in the past decade has been in from late 2008 through mid-2009, when analysts and economists were convinced that we would see another Great Depression. While the economy hasn’t been great these past five years, this scenario certainly hasn’t materialized, and we had an incredible run in stocks. Now stocks are higher and everybody loves them.
As crazy as this sounds, this is a cycle that will forever repeat itself, and your best approach to investing is to go against the grain. When you see rising stock prices and broad optimism in an environment that warrants the opposite opinion it is time to sell, or to at least take profits and look for opportunities elsewhere.
So what will happen in the second half of 2014?
First, we will probably see a couple of more new highs made in stocks, but this should take place early in the year. I suspect that we will see the highs for the year and that we will see the best selling opportunity in the broader market since 2007.
Second, second-quarter GDP figures will disappoint those who assume that the first quarter GDP decline was a onetime aberration. Reality will start to set in that we are in a recession.
Third, we will see volatility in safe haven assets, but weakness in gold, silver and other commodities should be bought. These markets are largely despised by analysts, and yet they are in heavy accumulation in the eastern part of the world. Escalating geopolitical tensions will also bolster these markets.
Given these points, the time to take action is now. There has rarely been such a large disparity between market behavior and sentiment and economic reality. Rather than attempting to rationalize it, you should simply exploit it.
Disclosure: Ben Kramer-Miller owns gold and silver coins, as well as select gold and silver mining shares.