Remembering Last Year’s Markets

There is lots of talk about how this incredible rally from the beginning of the year and even from last Oct 3 is just a mirage, that it cannot last. We often hear this from those less fortunate – those on the sidelines.

Of course, much of that chatter is coming from those who have gotten it totally wrong, while those on the right side feel emboldened and argue for more upside. Indeed, market results create binary opinions with winners and losers crying out to rationalize their stance.

We’re currently at the end of the first quarter. The economy is growing again (albeit slower than hoped for), the Fed is still engaged and it appears the armageddon from Europe is off the table (for now).

China is slowing their hot economy (as evidenced from the weaker flash PMI) but we already knew that (they told us two weeks ago!). The election in 8 months may bring some serious changes to Washington (oh, we can only hope!). Markets are at/near multi-year highs, reflecting the optimism seen in recently solid economic data.

Further, the volatility index is extremely low (circa 15) reflecting a boldness to invest/chase risk assets. Oil prices are elevated again, gold still hovers above 1600 while the dollar remains competitive vs other world currencies.

Let’s take a look back at 2011 and see if there is something that can guide us for the rest of the year. Ironically, the markets took a similar path (higher) in the beginning of the year – and with the disruptions from the ‘Arab Spring’ in Tunisia, Egypt and Libya – markets seemed to take it all in stride, complacency was high and not much worry was present.

Growth was looking steady as the market reflected optimism about the year ahead, but the Japan earthquake/tsunami threw a monkey wrench into that forecast. A disturbance the size of the tsunami becomes a gamechanger with adjustments to assumptions made almost immediately. Unplanned events are always surprising, difficult and painful but making the changes are necessary.

Later in the year we had the Greek drama starting to play out, which made for an even more uncertain World. Then we had the political bumbling over the debt ceiling – and a punishing smackdown from S&P, which lowered the US debt rating below AAA. Markets swooned and volatility picked up in a big way. Playing the extreme moves in markets up and down paid off handsomely. Still, the markets managed to make it through the turmoil in one piece.

So, what can we learn from 2011? Last year was one of the toughest and most challenging environments we have seen in quite some time. I spent a great deal of time sitting in cash in many accounts just waiting for the turn – which didn’t happen for me until the beginning of this year.

Being complacent is never a good place to be, but being active and moving your feet, accepting when you are wrong and being patient is where I like to be. While we are not about predicting events if you are ‘in’ but not prepared by keeping one hand on the exit door you can be hammered – mercilessly.

As positive sentiment and optimism build the margin for error gets smaller. Therefore, being cautious after a big run is more prudent than going all in with the rest of the crowd. Many lost money in 2011 because they were fighting the trend and not listening to what the market was telling them (the same has been happening to the bears so far this year). Will that be you in 2012? The lesson: Pay attention to what the market is telling you and adjust accordingly.

Bob Lang is the Senior Market Strategist for options trading newsletter Explosive Options