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Targeting an Initial 50% Long Position

(August 11, 2011)

Dear Subscribers and Readers,

The chief mistress of Louis XV, Madame de Pompadour, is one of the greatest seductresses in history.  Despite her commoner roots, Madame de Pompadour—through a combination of charm, intelligence, connections, politics, theatrics, and good relations with the Queen Consort of France, Marie Leczinska—was able (unlike Louis XV's past mistresses) to have a lasting influence on him and the court until her death.  More important, Madame de Pompadour possessed actual ability and refinement.

As Newton's and Einstein's scientific ideas became mainstream in the 20th century—and especially after the fall of the Berlin Wall—the world, while prosperous, became a little boring. The Cold War era of secret government agents, spy planes, and a common enemy lost its allure among the American populace.  Gone also were the myths—those of ancient Egypt, Greece, and Rome as students became more “practical” and studied finance, economics, engineering, and business.  The Space Race no longer mattered.  While the liberalization and civil rights movements allowed women and minorities to explore more life and career options, many of us could no longer find any “outlet” to channel our energies and passion, with the exception of work and family life.  The advent of the internet and social networking meant we could now find out what our neighbors and friends are up to at any moment—thus eliminating any remaining intrigue and mystique in our lives.  Suddenly, that trip to Spain, Thailand, Fiji, New Zealand or even the North Pole doesn't sound so exotic and exciting, especially once those holiday photos are posted real-time on Facebook.

In today's age of rationality, material comfort and political correctness, each of us yearns to be seduced; to crave for excitement.  This urge is especially powerful for the repressed (by the church, family heritage, significant other, etc.); or those who never quite satisfied those childhood dreams.  Quoting the book “The Art of Seduction”:

Louis XV had a powerful inferiority complex.  The successor to Louis XIV, the most powerful king in French history, he had been educated and trained for the throne—yet who could follow his predecessor's act?  Eventually he gave up trying, devoting himself instead to physical pleasures, which came to define how he was seen; the people around him knew they could sway him by appealing to the basest parts of his character.

Madame de Pompadour, genius of seduction, understood that inside Louis XV was a great man yearning to come out, and that his obsession with pretty young women indicated a hunger for a more lasting kind of beauty.  Her first step was to cure his incessant bouts of boredom.  It is easy for kings to be bored—everything they want is given to them, and they seldom learn to be satisfied with what they have.  The Marquise de Pompadour dealt with this by bringing all sorts of fantasies to life, and creating constant suspense.  She had many skills and talents, and just as important, she deployed them so artfully that he never discovered their limits.  Once she had accustomed him to more refined pleasures, she appealed to the crushed ideals within him; in the mirror she held up to him, he saw his aspiration to be great, a desire that, in France, inevitably included leadership in culture.  His previous series of mistresses had tickled only his sensual desires.  In Madame de Pompadour he found a woman who made him feel greatness in himself.  The other mistresses could easily be replaced, but he could never find another Madame de Pompadour.

Most people believe themselves to be inwardly greater than they outwardly appear to the world.  They are full of unrealized ideals: they could be artists, thinkers, leaders, spiritual figures, but the world has crushed them, denied them the chance to let their abilities flourish.  This is the key to their seduction—and to keeping them seduced over time.  The Ideal Lover knows how to conjure up this kind of magic.  Appeal only to people's physical side, as many amateur seducers do, and they will resent you for playing upon their basest instincts.  But appeal to their better selves, to a higher standard of beauty, and they will hardly notice that they have been seduced.  Make them feel elevated, lofty, spiritual, and your power over them will be limitless.

The late 1990s in many ways provided the perfect environment for the stock market to seduce the masses, namely the seduction to invest in technology and internet stocks.  Americans needed an outlet—not just for their savings (which were at record highs)—but also for their repressed desires and yearn for excitement.  The bull market also provided an intellectual and spiritual touch, as every upswing in a semiconductor or biotechnology stocks further reinforced investors' self-confidence.  The market was proving them correct—surely they were more intelligent than what college professors (whose meager salaries could not compare to their stock market gains) told them 10 or 20 years ago?  And given the potential for these companies to change the world—in essence shifting from an information to a biotechnology era—surely investing in these stocks were a patriotic and a spiritual endeavor?  Many of these investors also realized the ideal of a Jesse Livermore, Bernard Baruch, or even JP Morgan in them in the late 1990s.  Like virtually all seductions, though, this was not to last.

The greatest danger in a seduction lies not in hate, repulsion, or resentment—but simply indifference.  Extending this analogy, it is not the lack of earnings, high interest rates or even financial dislocation that characterizes major bear market lows (July 1932, April 1949, and April 1982).  It is the genuine lack of interest or resources to invest in stocks.  By 1932, families were more concerned with feeding and clothing themselves than to invest in the stock market; and whatever funds they had invested needed to be spent on food and clothing.  By 1949, investors haven't witnessed a major bull market in 20 years; and no respectable college graduate went to work for Wall Street.  Ditto for April 1982.  Valuations did not matter at those times (although they were good entry points, in retrospect).

Today, with the recent bull market still etched into people's memories (especially in emerging markets), and with the clever invention of automatic 401(k) deductions, I cannot imagine a revisit to the March 2009 lows anytime soon.  While I understand there needs to be a revolutionary change in much of the developed world's social welfare programs, many major countries are coming to this realization (with the exception of Japan).  As I mentioned, Italy has no imminent solvency problem as long as its 10-year yield remains below 6.75%.  While the Italian leadership is still dragging its feet, I believe a deal that further slashes its budget deficits will be finalized this summer.  Combined with the ECB's purchases of Italian and Spanish sovereign debt, I am looking for the markets to stabilize this summer or fall (autumn).  With the S&P 500's dividend yield now at 2.3% (higher the 10-year Treasury yield), and with its P/E ratio at its lowest since October 1990 (please see below chart courtesy of, I find U.S. large cap equities to be quite attractive.

That said, there needs to be a confluence of events in order for the masses to be “seduced” back into stocks again.  There needs to be a theme or a series of technological innovations (and commercialization) that could change the global economy in a revolutionary way and capture the imagination of investors, such as the commercialization of the quantum computer, second-generation biofuels (which would replace gasoline as a transportation fuel almost overnight), carbon nanotubes, etc.  As such, while we believe stocks to be a good buy, we are not looking for a resumption of the bull market in any major way.  In the meantime, a 2.3% dividend yield (especially given the historically low earnings payout ratio) is very worthwhile, especially in a tax-free account.

We are thus looking to initiate a 50% long position in our DJIA Timing System as soon as feasible.  This position could be a one-week trade; or a multi-month position.  Much will depend on the market action (and policy action) going forward.  Sure, neither our sentiment nor our liquidity indicators are yet signaling a sustainable bottom.  We will find out more later today.  But should the stock market take another dip in trading later today, we will likely go 50% long first, and reevaluate this weekend.  Subscribers please stay tuned.

Signing off,

Henry To, CFA, CAIA

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