FYI | May 04 2009
(This story was originally published on Wednesday, 29 May 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere.)
During my research over the past weeks, I was reminded of the Ten Market Rules To Remember, once upon a time put together by former Merrill Lynch chief market strategist, Robert “Bob” Farrell. Farrell was chief market strategist at the former high flying Wall Street firm for 25 years, until he stepped down in 1992 to become a senior investment advisor. A position that he held until 2004.
By the time he retired, Farrell had worked 50 years (!) for the same firm. That in itself is already a more than special achievement. During his tenure as chief market strategist, Farrell was named best market timer for 16 years (out of 25). It is thus not difficult to see why he was inducted into the Wall Street Week Hall Of Fame within a year after switching into a new role in 1993. Farrell is part of Wall Street legend.
Let’s start with the Ten Market Rules To Remember:
1) Markets tend to return to the mean over time.
2) Excesses in one direction will lead to an opposite excess in the other direction.
3) There are no new eras – excesses are never permanent.
4) Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
5) The public buys the most at the top and the least at the bottom.
6) Fear and greed are stronger than long-term resolve.
7) Markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names.
8) Bear markets have three stages – sharp down – reflexive rebound – a drawn-out fundamental downtrend.
9) When all the experts and forecasts agree – something else is going to happen.
10) Bull markets are more fun than bear markets.
Thus were fifty years of top Wall Street experience and insights summarised in ten simple rules. I recommend readers of this editorial print the list out, or write it down and keep it somewhere where it can easily be found. Re-read whenever your memory needs refreshing.
The two rules that caught my attention were numbers 8 and 9. If we take guidance from Farrell’s observations, then the current discussion about whether we have seen The Bottom or not becomes merely a side-issue. The real discussion then becomes: is this rally in risk appetite, that has now seemingly landed in a struggle, the “reflexive rebound” Farrell talks about, or not?
If it is, there could be a lot more upside potential around the corner. One of my favourite market commentators, soon departing chief economist at (pure coincidence) BA-Merrill Lynch, David Rosenberg recently pointed out such “reflexive rebounds” can last for many more months and take equity indices much, much higher – as long as investor hope can be kept alive.
Taken from this perspective, one can only conclude share market action in April has been nothing other than encouraging, to say the least. It all started in March, taking everyone by surprise, and let’s face it: nearly nobody believed it was the real thing from the moment share markets took off on a sudden buying frenzy in financials. Even those who predicted the rally, such as US banking guru du jour Meredith Whitney, were merely making the prediction on the basis of anticipated short covering, not because they thought this bear market had run its course.
During the eight weeks of this rally, I have repeatedly stated it wasn’t so much the rise, but more so the subsequent retreat that would determine whether this market had grown strong enough for more (sustainable) gains this year, or not. I still think that will prove to be true. The problem is, however, I have been waiting for this market to retreat for at least four weeks now, and it simply hasn’t happened.
Take a look at rule number nine (above). Could the problem be that too many market participants are waiting for share markets to fall back, and thus it is not happening?
I am a firm believer the majority view in financial markets is more often wrong than right. The longer I analyse financial markets, the more examples I accumulate to further strengthen this view. (Again confirmed by the fact Bob Farrell put it in his list of ten rules as well).
But what if the majority believes this rally cannot last, it will soon all come to an end and we will see major share indices re-testing the March lows shortly?
Could this mean that share markets won’t retreat (much) at all?
The theme was picked up by analysts at the institutional dealing desk at GSJB Were this week. Regular readers will remember them: they were the ones who in August last year predicted share markets were likely to fall much further because history showed that always happened whenever share markets were down by 12% or more by September.
This week the insto desk at GSJBW reported all their clientele appears to be interested in is when the next sell-off will commence, “just like what happened in the 1930s”.
The analysts have done their best pointing out to their clientele that history might provide us with some valuable insights, and maybe with some probabilities and potential scenarios, but it never does give us exact blue prints of what will happen in the future.
Maybe, suggests the team at Weres, the main problem with the current market is that too many people are short, or sitting on the sidelines, waiting for share markets to take out new lows, but since there are no sellers around, share markets cannot seriously fall. Instead, one would have to assume the longer share markets refuse to fall, the more feasible the idea becomes that this rally might not fail at all. Conversely, this could become a self-fulfilling process.
Especially since the amount of positive reports, and encouraging data, is on a steady rise.
The insto desk at GSJBW is no exception. This week the desk issued a report predicting US shares had seen the worst in this bear market. Historically, states the report, US shares always peak or trough at the same time as US consumer confidence does. For instance, in early August 2007 US consumer confidence peaked, and so did US share indices soon after (at the time, recalls the report, US consumer confidence had jumped to a six-year high, that should have served as a warning signal to everyone).
Going further back into history, the report states US consumer confidence equally peaked in january 2000, and so did the Dow in the same month. Similar peaks occurred, both in US consumer confidence and the Dow, in October 1968, December 1972 and in September 1987.
Those were all parallel peaks and on each occasion what followed next was a drawn-out and nasty bear market, states the report.
The analysts believe the same principle applies when US consumer confidence hits a new low. It means US shares have seen their lows as well.
US consumer confidence hit a new all-time low in February.
History shows, states the report, one year after US consumer confidence hits a bottom the US share market is up by 26%, on average, and “this time will be no different”.
All very positive, until you realise US share market indices are already up by some 26% since early March.
Indeed, a closer inspection of the data mentioned in the report reveals that often, but not always, the first six months after US consumer confidence bottomed, the Dow records its biggest gains. In 1974-1975, for instance, US consumer confidence bottomed in December and the Dow subsequently rallied 41% over the following six months. However, one year after, and six months beyond those 41% gains, the Dow was only up by 39% (meaning the index had actually lost 2% net over the second six month period).
Similarly, in 1980 the Dow rallied 22% after consumer confidence bottomed in May of that year, and that’s exactly what the gain was after twelve months. The same scenario happened again in 1982, only the rally took the Dow 37% higher, both after six and twelve months.
In 1992 the Dow only rallied 5%, and was still up 5% after twelve months.
The big exception, the one that GSJBW instos like to take guidance from, occurred in February 2003 when confidence troughed and the Dow rallied 19.3% during the next six months. The Dow was subsequently up a total 33% after twelve months.
So, I hear you ask, what has made the key difference in all those bear markets?
The report doesn’t provide the answer, but if you’d ask me, I’d say it probably was a difference in the strength of economic recovery. We all know what happened after the bear market of 2000-2003. We all know very well, because the bull market that followed next is what has taken us to where we are today.
Maybe what the GSJBW report has proved is that this market may well have seen its lowest levels (even though that wasn’t what the desk was aiming at). What happens next is still dependent on what happens in the global economy.
With these thoughts I leave you all this week.
Till next week!
Your editor,
Rudi Filapek-Vandyck
(As always firmly supported by Greg, Andrew, Chris, George, Grahame, Pat and Joyce)
