All the signs are coming together. The fear, the outflows, the new tools to hedge, the focus on bonds and stability, the ETF story and the sentiment indicators. Each and every one of these elements is pointing toward the end of volatility – not the beginning.

I am sorry – bear markets do not begin with everyone already expecting a bear market. They don’t begin with everyone already aware of all the Black Swans. They don’t begin with the crowd already buying the “safe” item, in this case perceived as bonds.

They start when no one expects them, when everyone expects upside, when the crowd is bullish and bonds are foolish “if you are looking for real growth in assets.”

That Nagging Feeling

Here is yet another nasty little secret of markets, lows, highs and building wealth over time. Every major low has the same general characteristics. For some odd reason, those elements are the very same elements which make us afraid of the future – and hence, of taking any risk.

Notice that when markets are up, rallying and hitting new highs, there is no massive overlay of fear about the future. The crowd feels better, safer, when they are operating as a crowd. Fear and greed actually blind too many to the facts of risk and value.

Back to that nasty secret:

Every important lows feels the same…it is scary, the future is dark, the news is bad, companies are struggling, markets are shaky, headlines are all bad, earnings are struggling, mistakes seem to be unfolding across the board, risk is perceived as high, problems are too big and will take a long time to remedy – if they can be remedied at all – all the while, the masses want to know everything about hedging.

There is one more thing that goes with all that mess: low prices. Period. End of story.

Company-specific or market-wide, the story is the same. I wish this was not the case. I wish good values were attained when it all feels comfortable. The fact is however, that this rarely – if ever – happens. Bad news, bad feelings, bad mojo, bad history, bad future are all the hallmarks of lows.

Here is the kicker: That is perfectly normal.

Case in Point

This morning Apollo Management took over ADT for a 51% premium to where they closed on Friday. Think about that for a second. Here is a company that is one of those old-line entities – the silbver tape on the window and the box at the door where you punch in your code for your alarm. It was a lost cause.

But also remember this: buyout guys are not there to do anyone any favors. They want to make as high a return as possible on their capital. They fulling expect to see their capital grow 2 to 3 times over – and often more. It’s why risk is always present.

The point? They paid a 51% premium to what the market fears had priced ADT in recent weeks. And, they fully expect more value to be squeezed from this process. In other words, they don’t come in and pay full value.

Reality Check

Today, everyone is once again scared of stocks (see sentiment charts below) – they hate stocks. They are simply too dangerous – at about 14 times earnings, many less so. However, the safe stuff – bonds – which cannot mathematically repeat their last 30 years which built that comfort, are now priced at over 50 times earnings.

Let me tell you one more thing about business cycles and the use of debt/equity. A good CFO knows that when rates are at record lows and your cash yield in your company is higher, you are better off borrowing to buy in that equity for later use. As debt becomes due years later – you re-measure your yield and agree to pay a little more in cost for a rollover. If indeed rates have escalated a good deal, what do you do?

Well, simple – if rates have escalated in our environment, it would mean the economy has gotten much better, fear has ebbed and normalcy has begun to return. That growth angle would suggest earnings were up and efficiencies were improving – making our stock more valuable than when we bought it in years early. In this case, we would simply sell the stock back to the public in an equity offering – at prices higher than what we bought it back from – and then pay the debt off with the new funds from the equity offering.

Why point this out? Because headlines these days want to scare you into believing that record buybacks are somehow terrible and scary and dangerous. Actually, they are smart, well-timed, productive, a good use of capital and should be fulling expected in a word of masses clamoring for bonds for as far as they eye can see.

If you can borrow at 4% for 20 years – and your return on equity is 3 or 4 times that over time, one would be a fool not to do the same thing all the CFO’s are doing. Don’t let the big numbers scare you into thinking it is automatically bad.

Now For That Terrible Sentiment

By the way, I say “terrible” – I mean good….for long-term investors.


The two charts above show the bull and bear readings in the most recent surveys last week. The first chart shows the bull reading. Less than 1 in 5 are bullish on stocks in the AAII survey – same for advisors.

I have matched a red dot at previous lows in this reading. The red line overlay you see streaming up the chart is the SP500 average. Note where the red dots lie in the pattern of the S&P index.

Same again for the second chart – only this is for the level of bears. Nearly 1 in 2 are now outright bearish – the rest of the 100% are in the correction camp. In other words, 4 out of 5 see a correction or are outright bearish.

I am sorry – whether or not it feels ugly, scary or dark – this is not the picture one sees at the beginning of bear markets. At least not since the early 80’s when I started in the business.