GO
Loading...

Ready for a pullback? Don't try to time it

Getty Images

Markets go down. It is an unpleasant truth for all investors.

They haven't gone down much in a long while.

We've been hearing lots of questions about raising cash and riding out the downturn from the sidelines. Great. I'm in. Tell me when the downturn will start, how deep it will go and when it will be over.

I've never known anyone who has been able to get all the phases right. One of the toughest truths about investing is that NO ONE has any idea what the market may do in the short term.

(Read more: The precarious nature of corporate profits)

We could at any point begin the next 20 percent move higher or lower. The real job for serious investment managers is to construct and maintain portfolios equally prepared to benefit from the upturns and defend and endure the downturns.

Mortgage applications are down a good deal. Wells Fargo suggests a 30 percent reduction and JPMorgan expects a loss from that division.

While stocks have continued to climb against the rhetoric of Fed tapering, the bond market has not.

The yield on the 10-year Treasury note has increased by about 1.25 percentage points since May when Chairman Ben Bernanke first suggested the Fed may reduce the $85 billion in monthly bond purchases.

The Fed hasn't done anything yet, but the bond market has. We will learn the Fed's decision later this month. But, what we know is that higher mortgage rates have significantly cooled consumer appetites for mortgages.

(Read more: Housing bubble? Yep, we've got one)

The Beige Book was released, and the Fed commented that consumer spending had continued at a good pace, and therefore, the economic recovery was intact. But that doesn't ring true to us.

There are a lot of Americans who are not employed or are underemployed. Wage gains have been minimal, and hours worked are unchanged.

So if Americans are to continue spending, they need money to spend.

There aren't a lot more of them earning money either because they have new jobs, are working more hours, or have received raises. The rise in interest rates makes borrowing more expensive, so where will the consumer get the money that the Fed wants them to spend?

The reality is that most of the spending increases continue to come from the well-to-do while moderate-income Americans continue to struggle. The recovery needs to become more balanced before we are convinced of its efficacy.

Stocks aren't cheap.

They're not over-the-top expensive, but they're not cheap.

(Read more: Bulls at JPMorgan get an earful from Asia clients)

The increase in share prices from the 2009 lows has been driven both by earnings increases and by an increase in price-to-earnings multiples. However, it must be remembered that profit margins for S&P 500 companies are close to all-time highs.

This is important because profit margins are mean-reverting. Today, corporate margins are running at about 9 percent compared to a 6 percent long-term average. It should not be a surprise, therefore, when profit margins contract. While this doesn't mean losses, it will cause pressure on earnings growth at some point in the future.

Expensive markets can last a long time. They can grow ever more expensive.

At various points the hot-air hype is leaked, and prices drop and settle. When investors realize that the world has yet again failed to stop spinning, they begin to buy again.

While we are dogged, determined, disciplined and vigilant, we are not market-timers. We have been through markets like this before.

Warren Buffet is not jumping in and out of stocks he holds at Berkshire Hathaway. If Buffet can't do it, who can?

As the rhetoric from Washington increases and emotions get stronger, rely on solid investments that have endured tougher times than these. Emotion is the foe of the long-term investor. Don't let it be yours.

—By Michael K. Farr, president of Farr, Miller & Washington and a CNBC contributor.

Latest Special Reports

  • Financial advisors stress that now is the time for investors to get serious about year-end financial planning checkup.

  • From the birth of a child to college, marriage, and retirement, a successful investment path leads to the good life.

  • In a world of big box retail and e-commerce, successful business owners are taking new paths to Main Street success.

Investing