Saturday, October 25, 2008

Surprisingly, Bear Markets Don't Always End With a Bang -- Sometimes It's Just a Whimper

By Jason Zweig from The Wall Street Journal

Wall Street often resembles a blindfolded person looking in a darkened closet for a pair of black shoes that isn't there. With the Dow taking another battering in the past week, another round of futility is under way: the search for "capitulation."

There's a belief that the market can hit bottom only when vast numbers of investors finally capitulate, throwing in the towel and selling off the last of their stock portfolios. In theory, if you could spot this moment, you could make a killing buying at the bottom.

There are two problems here. First, capitulation is almost impossible to define. Second, even if you could get a positive ID on capitulation, that might not do you any good. Market lows aren't necessarily marked by tidal waves of frantic selling; just as frequently, stocks bottom out in a dull and lonely atmosphere as trading dries up and most investors no longer even care. Bear markets often end not in capitulation but stupefaction.

"The idea is, 'We'll know we've hit bottom when the fat lady capitulates,' " says finance professor Robert A. Schwartz of Baruch College at the City University of New York. "But she could just sputter instead, or capitulate more than once, or slowly slide around along the bottom." Warns Prof. Schwartz: "On the way down, you get a lot of faux capitulation. And how do you know, until after the fact, whether it is friend or faux?"

Oddly, even market pundits who believe in capitulation admit they can't define it. "Capitulation is a state of mind, without any specific definition," says Al Goldman, chief market strategist for Wachovia Securities. "You can't measure it; it's best identified in hindsight." Hugh A. Johnson, chief investment officer at Johnson Illington Advisors, says almost wistfully: "I wish I could quantify it for you so I could say, 'Here, this is capitulation.' But a lot of this is anecdotal. Talk to enough investors and you get an idea of whether we have capitulation."

Talk to them later, however, and you may get a different idea altogether. What seems like capitulation today will no longer qualify if the market goes even lower tomorrow. Mr. Goldman puts it best: "I think I'm right that we had capitulation on Oct. 10 [the day the Dow lost nearly 700 points]. But if we keep going down from here, then I would have to say that I was wrong and that it wasn't capitulation."

This is somewhat like insisting that your pet is a dog until you notice that it is meowing.

In truth, bear markets often end not in a crescendo of selling but a cloud of indifference. For example, take Dec. 6, 1974, a day that will long live in market infamy. The Dow closed at 577.60, down 45% from its levels in January 1973. Total trading volume was a tepid 15.5 million shares; a few days earlier, it had totaled only 7.4 million, tying the lowest level in more than three years. Lucien Hooper, one of the nation's leading security analysts, told The Wall Street Journal that day that the market was "just waiting the bad times out." Far from throwing in the towel, most investors weren't even at ringside.

"The most interesting thing about [the 1974 market bottom] was its dullness," veteran fund manager Ralph Wanger recalled to me. "It wasn't a crash, it was a mudslide. You came in, watched the market go down a few points and went home. The next day you went through the same thing all over again." And then, without a moment's warning, the bull woke up and took off. By Jan. 6, 1975, the market had shot up 10%, and a year after that the Dow had risen 54% from its 1974 low.

In short, bear markets sometimes end with a bang, sometimes with a whimper. You're more likely to see a unicorn in your backyard or a chimera in your kitchen than you are to spot an indisputable sign of market capitulation. The obsessive attention so many investors are paying to the huge swings in the Dow suggests that we may not have hit bottom yet; stupefaction seems not to have set in yet. What we can be quite certain of, however, is that stock markets around the world are already on sale. If you have cash to spare, put some to work. If you don't, save up until you do. But don't kid yourself into thinking that you will ever get a clear signal out of such an unclear indicator.

Thursday, October 23, 2008

Is it Different This Time?

Weston Wellington delves into his vast library of press clippings to offer perspective on the unpredictability of market movements, how the current market downturn compares to past bear markets, and the resilience markets have historically shown.


Sunday, October 19, 2008

WARREN BUFFETT: If you wait for the robins, spring will be over...

From The New York Times, 17 October 2008

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.


A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Saturday, October 18, 2008

PAUL KRUGMAN: Let’s Get Fiscal

From The New York Times, 16th October, 2008

The Dow is surging! No, it’s plunging! No, it’s surging! No, it’s ...

Nevermind. While the manic-depressive stock market is dominating the headlines, the more important story is the grim news coming in about the real economy. It’s now clear that rescuing the banks is just the beginning: the nonfinancial economy is also in desperate need of help.

And to provide that help, we’re going to have to put some prejudices aside. It’s politically fashionable to rant against government spending and demand fiscal responsibility. But right now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold.


Thursday, October 16, 2008

Joseph Stiglitz

Joseph Stiglitz explains why the economic crisis won't end just because the stock market does well... From Colbert Nation

Wednesday, October 15, 2008

The More Things Change . . .

Jim Parker, Regional Director, DFA Australia Limited

"The problem is leverage, clear and simple," was how one journalist summed up developments in financial markets, noting that markets were freezing up, liquidity was lacking and investors had become risk averse.1

The onset of recession, a weak US dollar and sinking real estate made for a gloomy combination, wrote another.2

The crisis had all the markings of the end of an era, observed a third,3 suggesting that it would take years to clean up the mess of debt and high-risk products left behind by the sharper operators of Wall Street.

The financial strains were accompanied by political tensions. In the US, the Bush administration was under attack over its handling of the war in Iraq, which had driven up oil prices, and its management of the economy.

Sound familiar? All of those observations were made within a few days of each other in January, 1991, more than 17 years ago.

At that time, the Anglo-Saxon economies of the US, Canada, the UK, Australia and New Zealand were all either in or flirting with recession.

The recession came on the heels of an era of financial excess, as exemplified on Wall Street by the junk bond king Michael Milken and in the movies by Gordon "greed is good" Gekko.

In the US, excessive and imprudent lending for real estate had contributed to the failure of hundreds of community-based 'savings and loans' institutions, triggering a multi-billion dollar government bailout.

In the United Kingdom, consumers who had leveraged themselves heavily to real estate suffered a severe blow when rising interest rates pushed house prices sharply lower, both in real and nominal terms.4

In Australia, too, market deregulation had given way to an era of increasingly reckless lending by financial institutions, which until that point had had little experience in managing risky commercial loans.5

The consequence in Australia was the failure of a number of major financial institutions, including the state banks of Victoria and South Australia, the Teachers' Credit Union of Western Australia, the Pyramid Building Society, merchant banks Tricontinental, Rothwell's and Spedley's and the Estate Mortgage trust.

Examining the causes of the early 1990s bust in the Anglo-Saxon economies, a Reserve Bank of Australia governor later observed that any boom built on rising asset values and financed by increased borrowing had to end.6

At that time, the crisis seemed intractable and insoluble. Journalists and economists talked of systemic breakdown and a global challenge for market capitalism, much as they are now.

Now, while no two market crises are ever the same, it is fair to say there are parallels between today's downturn and the events of early 1990s, particularly in the damage caused by excessive leverage and insufficient oversight by many financial institutions of the risks they were taking on.

For those who lived through that period as investors (or even market commentators), you might recall the sense of doom and gloom and the over-riding fear in the financial markets at that time.

The important point is that markets worked through that period of dislocation and uncertainty to emerge stronger. Indeed, the early '90s recession was followed by a stellar decade for equities, one that would have passed by those who had given up in 1991 and hunkered down in cash.

This is not to predict that today's markets are ripe for a similar Phoenix-like revival, but it is a sage reminder that nothing lasts forever and that if you want the returns available from risk assets, you need to stay in your seat...

Please email or text me if you would like a copy of the full article with tables... Andy

1'Deleveraging: Relief from a Big Debt Hangover', Corporate Cashflow Magazine,Jan 1, 1991
2'A Year to Forget? US Investors Left with a Chill After '90', Dallas Morning News, Jan 2, 1991
3'U.S. Securities Industry Going Through Rough Ride', Associated Press, Jan 2, 1991
4Roger Bootle, 'UK High Street Has Echoes of 1990s Recession', Daily Telegraph, Jan 15, 2008
5Ellis Tallman, 'Australian Banks during the 1986-93 Credit Cycle', Economic Review, 2000, Q3
6Ian Macfarlane, 'The Boyer Lectures: The Recession of 1990 and its Legacy', ABC, Dec 2006

Sunday, October 12, 2008

Recessions and Stock Markets / Resilience of Capitalism

Mark Hebner, President, Index Fund Advisors

Mark has also posted several interesting pieces on his web-site over the past few weeks including references to "The Four Pillars of Investing" by William Bernstein. Chapter 6 is titled Market Bottoms: The Agony and the Opportunity. It’s only 10 pages and Mark suggests that it is worth the read. In his section titled How to Handle the Panic Bernstein says:
What separates the professional from the amateur are two things: first, the knowledge that brutal bear markets are a fact of life and that there is no way to avoid their effects; and second, that when times get tough, the former stays the course; the latter abandons the blueprints, or, more often than not, has no blueprints at all.

See also Mark's presentation: Should You Be Worried About Your Investments?

Friday, October 10, 2008

New Quote of the Day

I've never been a big fan of financial advisers, but now I'm sympathetic to the hand-holding function they perform.

This isn't the time to be making any major financial shifts, although there is one caveat: I do think all portfolios should hold a tiny sliver of gold. I haven't looked at my portfolio. I only do that every January, when I rebalance.

Burton Malkiel 76, professor of economics, Princeton University; author, A Random Walk Down Wall Street

Good news is a scarce commodity...

Out of the gloom world growth is emerging

From Robert Bowerman's Smart Investing Blog

Good news is a scarce commodity on investment markets these days.

But this week's report card from the International Monetary Fund on the global economy and its forecasts of economic growth offer some interesting insights into the scale of the impact of the turmoil of the financial crisis on real world economies as measured by gross domestic product.

One of the big concerns of recent market events is that the major shocks that the global financial system is reeling from will - to use the US analogy - transfer from Wall Street to main street.

Now given all the gloom and doom about credit and equity markets in the US it may be a surprise that the IMF is forecasting that even with the subprime mortgage collapse and its subsequent ripple effects the US economy is tipped to narrowly miss dipping into recession. The IMF is forecasting GDP growth in the US next year of 0.1%. That is hardly dynamic growth or signalling a sprint-like recovery but given the daily dramas played out on Wall St most people would probably have said the US is already in recession and the real question is how deep a recession it will be.

The caveat that some of the world's leading economic minds have put on that forecast is that the emergency measures put in place by governments in the US and Europe and our own Reserve Bank's interest cut this week succeed in restoring confidence in the financial system.

Whether the US does dip into recession is moot but the IMF forecasts underline the separation between the financial and the non-financial markets. Clearly main street - the non-financial economy - is doing its bit to cover the Wall St malaise.

The good news for the Australian economy is two-fold: For a start our economic growth is predicted to be 2.2% in 2009 - subdued compared to recent years admittedly but way better than our American cousins and most of western Europe.

So the old, developed world is expected to do it tough for the next year or two. But let's look at some of the developing countries. China is of course the obvious first point of reference and the IMF is predicting lower growth for this emerging economic colossus but that sees economic growth pegged back to 9.3% (down from 9.7%).

There is a new axis of economies emerging on the world economic stage - the so-called BRIC countries (Brazil, Russia, India and China).

According to the IMF while these emerging economies are certainly not immune from the global financial crisis the forecast growth is robust and looks downright rosy compared to the so-called "developed" economies.

The IMF is predicting economic growth for India of 6.9%, Russia 5.5% and Brazil at 3.5%.

Now that is not going to be enough to offset the impact of the developed economies slowing dramatically. And while there has been much discussion about "decoupling" of economies like ours from the US impact the reality is that there is no such thing in these days of globalisation.

Indeed the IMF says world economic growth in total is decelerating fast and expects the recovery to be "unusually protracted" as financial markets continue to "deleverage". In plain language that means we have to get the toxic debt that was built up in the financial system out - a process that is well underway - while restoring confidence in the financial system is developing as the biggest challenge for regulators and governments around the world.

As a result the IMF has downgraded its growth forecast for world output to 3% - which is down from 5% in 2007.

The IMF is forecasting world economic growth will continue to slow for the rest of this year and the first half of next year before beginning a gradual recovery later in 2009.

Australia cannot expect to be immune from that slowdown - slower world economic growth means weaker demand for commodities - but the good news is that we are better placed than many other developed countries to weather the storm.

Wednesday, October 08, 2008

It is time for comprehensive rescues of financial systems

By Martin Wolf, from

As John Maynard Keynes is alleged to have said: “When the facts change, I change my mind. What do you do, sir?” I have changed my mind, as the panic has grown. Investors and lenders have moved from trusting anybody to trusting nobody. The fear driving today’s breakdown in financial markets is as exaggerated as the greed that drove the opposite behaviour a little while ago. But unjustified panic also causes devastation. It must be halted, not next week, but right now.

The time for a higgledy-piggledy, institution-by-institution and country-by-country approach is over. It took me a while – arguably, too long – to realise the full dangers. Maybe it was errors at the US Treasury, particularly the decision to let Lehmanfail, that triggered today’s panic. So what should be done? In a word, “everything”. The affected economies account for more than half of global output. This makes the crisis much the most significant since the 1930s.

First of all, the panic must be dealt with. This has already persuaded some governments to provide full or partial guarantees of liabilities. These guarantees distort competition. Once granted, however, they cannot be withdrawn until the crisis is over. So European countries should now offer a time-limited guarantee (maybe six months) of the bulk of the liabilities of systemically important institutions. In the US, however, with its huge number of banks, such a guarantee is neither feasible nor necessary...


Monday, October 06, 2008

Like J.P. Morgan, Warren E. Buffett Braves a Crisis


In the midst of a financial crisis, a towering figure of American business steps forward with his reputation and financial resources for public good and personal gain.

Their times and personalities are vastly different, of course. But J. Pierpont Morgan’s role in the Panic of 1907 has its echo in Warren E. Buffett’s actions during the current financial troubles.

“What Buffett is doing is similar in ways to what Morgan did in 1907,” said Richard Sylla, an economist and financial historian at the Stern School of Business at New York University. “It’s what you might call profitable patriotism.”

Comparing the two men and their moves in periods of market turmoil, just more than a century apart, reveals how much some things have changed over the years and how other things have not, according to business historians and finance experts.

Morgan was 70 during the financial crisis of 1907, in the twilight of his career. Mr. Buffett is 78. Like Morgan so long ago, Mr. Buffett now finds himself “at the center of things; he draws headlines and he inspires confidence,” said Robert F. Bruner, dean of the Darden School of Business at the University of Virginia, and a co-author with Sean D. Carr of “The Panic of 1907: Lessons From the Market’s Perfect Storm” (Wiley, 2007).

In the last two weeks alone, Mr. Buffett has exercised his influence mainly by investing in embattled blue-chip companies, committing a total of $8 billion to Goldman Sachs and General Electric. He drove hard bargains and invested on favorable terms.

Mr. Buffett has been fielding many phone calls recently because of his cash, his reputation and his ability to act quickly. The G.E. investment, for example, was put together in a matter of hours, after G.E. reached out to Mr. Buffett through his longtime banker at Goldman Sachs, Byron D. Trott.

“In the last few weeks, everyone who has been in trouble or thought they were in trouble has called him,” said Alice Schroeder, author of “The Snowball: Warren Buffett and the Business of Life,” a biography released last week by Bantam. Ms. Schroeder, a former Wall Street analyst, is the first Buffett biographer to receive his cooperation, and she said she talked to him regularly.

The companies benefit from the credibility dividend that comes with the Buffett endorsement. Last Thursday, the day after he announced his investment in G.E., the company raised more than $12 billion in a public sale of shares.

Mr. Buffett is also the largest shareholder in Wells Fargo, which last Friday swept in with a $15 billion bid for another banking company, Wachovia, offering seven times what Citigroup did at the start of the week.

Mr. Buffett is the world’s richest person, topping this year’s ranking of billionaires by Forbes magazine with $62 billion. Mr. Buffett has pledged to give most of that fortune to charity upon his death.

Yet even more than money, Mr. Buffett brings the reputational capital that comes from being a peerless long-term investor, revered for his acumen and sound judgment.

“So there is immense signaling power to Buffett’s moves, showing others that now may be a good time to invest,” Mr. Bruner said...


Wednesday, October 01, 2008

Quote of the Day

"I have not looked at any of my holdings and don't intend to. I don't want to be tempted to jump because I think I'd be more likely to jump in the wrong direction than the right one. My advice has always been to choose a sensible diversified portfolio and stop reading the financial pages. I recommend the sports section."

Quotation attributed to Richard Thaler, professor of behavioral science and economics, University of Chicago Graduate School of Business.

Young, Lauren. "Where the Pros Are Putting Their Own Money." Business Week, October 6, 2008.

Where Will the Money Come From?

from Paul Krugman's New York Times Blog, 30 September 2008

In the end, the US government will rescue the financial system — not today or tomorrow, maybe not Thursday, but soon, and for the rest of our lives, or anyway until the next crisis.
But, people ask me, where will we get the money? Won’t we have to borrow it from the Chinese?
Actually, no.

Ten years days ago, I explained that the Paulson plan would actually move money in a circle. No outside financing would be needed.

What if we turn to a different and better plan, one that recapitalizes the financial system. Won’t that need outside funds? No.

First, a real-world example, the rescue of Wachovia. The FDIC got Citi to take over Wachovia’s assets and liabilities with a deal under which the feds limit the losses — they will cover any losses on mortgage paper over $42 billion — in return, basically, for receiving a share of ownership, in the form of warrants and preferred stock. No actual money changed hands, which illustrates a fundamental principle: recapitalization doesn’t mean laying out real money, at least initially — it just means having taxpayers take on some of the risk.

A large-scale recapitalization would probably take the form of a giant swap of debt for equity: the Treasury would issue several hundred billion dollars’ worth of bonds, and give them to financial firms in return for preferred stock. The bonds wouldn’t have to be sold to outside buyers — they would simply be credited to firms’ balance sheets.

The effect would be that if the financial firms did well, taxpayers would share in their good fortune via those stock holdings; if firms did badly, they could meet their obligations by selling some of those bonds, which would cut into the value of all their stock, including the stuff Uncle Sam owns. So as in the case of Wachovia, what’s really happening is that the taxpayers are taking on some of the risk.

So is all this magic? No, over time Treasury has to pay interest and principal on the bonds it issues; the value of the bonds comes from the fact that people believe the US government can do that, which ultimately comes from the government’s ability to raise taxes. If investors lose faith in that …

For now, however, none of the rescue schemes we’re talking about involve large-scale net borrowing from abroad.