Posts Tagged ‘bear market’

Is this a bear market rally or a turning point?

Sunday, May 17th, 2009

The global stock market has been rallying for the past couple of months already. There have been talks of “green shoots” of economic recovery. There are hopes that China’s stimulus spending will bring out renewed demand for Australian commodities. Already, there are reports of record Chinese demand for commodities (see China on buying spree).

We heard of many retail investors piling into the stock market, not wanting to miss out in the turning point. Since the stock market tends to be a leading indicator of future economic activity, many are seduced by the idea that this rally is predicting a turning point in the global economy. Unfortunately, as with many cliché ideas, this is only half-true. This is an example of a mental pitfall called lazy induction (see Mental pitfall: Lazy Induction).

To be more precise, the stock market anticipates but not predicts turning points. What this means is that economic recoveries are followed from recoveries in the stock market, but a stock market rally does not necessarily indicate an economic recovery. A very good example will be the number of bear market rallies in the chart of the Dow Jones from 1929 at Bear market rally on the works?.

Now, let’s take a read at what Marc Faber says about this rally in his latest market commentrary:

The economic news in the world is hardly getting any better, but the rate of economic contraction has slowed down somewhat as the  governments? stimulus packages begin to have some impact and as some replacement demand is starting to support consumption. However, to talk  already now about a sustainable economic recovery seems premature because whereas some sectors (autos) and regions may be stabilizing, others are still in a steep decline.

The global economy are declining, but the speed of decline is not as fast as the second half of 2008. Therefore, this stock market rally is anticipating that this reduction in speed is a turning point.

The next question to ask is this: will the stock market be lower or higher in 2010? Even Marc Faber admitted not knowing the answer to this question. Indeed, it is certainly possible to see another bout of breathtaking crash that can rival the panic of 2008. There can be many possible triggers for that, including:

  1. Collapse of a major European bank. Many big European banks lent so much money to Eastern Europe that their asset books are even bigger in size than the GDP of some European nations! Meanwhile, many Eastern European economies are in serious trouble, which means there will be many gigantic bad debts floating around. The European Union is an economic union but not a political union. Therefore, the European Central Bank (ECB) does not have the same level of authority and political support as the US Federal Reserve. Individual nations using the Euro as their currency cannot simply print money to bail out their financial system because they have surrendered their economic sovereignty to an intra-national authority. To do that, there can be a situation whereby taxpayers of say, Germany, are asked to bail out the taxpayers of say, Spain. Politically, this is too much to ask. Therefore, if a banking crisis is to hit Europe, the political deadlock can result in another panic in financial markets.
  2. Swine flu
  3. Collapse of Pakistan

At the same time, governments are already embarking in massive money printing (quantitative easing), stimulus and bailouts spree. As we said before in Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber?s view,

… while the deflationary pressures will continue, it can be slowed down via unconventional monetary policies (see ?Bernankeism and hyper-inflation?), gigantic fiscal policies, bailouts and even government fraud. The result will be a long drawn out affair, akin to a grinding trench warfare and a war of attrition on the real economy as credit contraction (IOU destruction) collide head on with money printing, massive government spending, stimulus and bailouts.

If government pumps so much money into the financial system, it is only a matter of time before asset prices rise again, not because of improving economic outlook but because of the sheer weight of money. The problem will be massive consumer price inflation once the Global Financial Crisis (GFC) is over, which is a problem for the next generation to solve. The outcome will be what we wrote in Zimbabwe: Best Performing Stock Market in 2007?.

In any case, no matter what happens, the peak of economic boom in 2006/2007 is over and will not be back soon. Investors who are expecting that will be disappointed.

Tags: , , , ,
Posted in Looking Forward, Market Observations | 8 Comments »

Marc Faber: Asset Markets May Rebound Within 3 Months

Tuesday, November 25th, 2008

Back in Bear market rally on the works?, we explored the possibility of a stock market rally in the context of a bear market. We wrote,

At such extreme levels, it is very possible that we will see a counter-trend rally soon. But please note two things:

  1. It does not mean that prices cannot go down further in the short-term. Who knows, perhaps there will be more panic selling in the days to come, thus bringing the technical indicators into even more extreme levels?

More than a month had passed and everyone could see that the panic selling had intensified. It is only since a couple of days ago that there was some kind of bounce. Naturally, many investors are extremely wary of this. Many of them will take this opportunity to sell.

Interestingly, Marc Faber had this to say in this interview:

What you could see in the next three months is a very strong rebound in asset markets, in equities, followed by a selloff in bonds and eventually a sell-off in the dollar.

Why is the reasoning behind Marc Faber’s view?

Firstly, based on statistical probability, the market for stocks, non-government bonds and commodities are at a level that is even more oversold than the infamous 1987 crash. Therefore, based on history’s lessons, a rebound is likely to happen soon. As we mentioned before in Bear market rally on the works?, even during the infamous bear market of the Great Depression, there were many multi-month rebounds before stocks bottomed out in 1932. The only argument against this line of reasoning is the Black Swan argument (see Failure to understand Black Swan leads to fallacious thinking). Who knows, perhaps 2008 will go down in history as the worst ever bear market that is unprecedented in the entire history of human civilisation? In that case, as Marc Faber cautioned,

Statistically a rebound should happen, but if it doesn’t “the air is out” and the world faces an economy “worse than the depression of ’29 to ’32,” he said.

Next, the key to understand why a rebound can happen is that

But “I assure you if you throw enough money at the system, eventually you can reflate, especially in the United States,” Faber added.

What is happening is that despite the gigantic deflation in asset prices all over the world (around US$60 to $100 trillion of ‘value’ had gone up in smoke), governments are trying their hardest to pump liquidity (money and money substitutes) into the financial system and spending their way into budget deficits. Consequently, financial institutions are sitting on a huge pile of cash as they sell their assets and hoard it. The problem with ‘cash’ (the safest ‘cash’ is Treasury bills and government bonds) is that they have practically no return. Therefore, it is only a matter of time before the overwhelming volume of liquidity burst the seams and triggers a rally. As Marc Faber said,

If the market continues its sell-off, there will be more capital injections and more liquidity creation and one day it will trigger a huge rally where people rush out of cash into assets because they will become not concern about deflation but concern about the monetary impact of this liquidity injection on asset prices and so they rush in to hard assets whether it’s land or raw materials, in particular gold.

In such an environment, we will happen to the value investing philosophy? We will talk more about that soon.

In the mean time, what do you think will happen to the global equity market in 3 months time? Vote and express your thoughts here! (Today, we will do something a little different- we will close the comments for this post so that you can vote and comment here instead. You need to register first before you can comment and vote).

P.S. In 3 months time, we will re-visit this vote and see whether you, our dear readers, are right or not. 🙂 We will close the vote in 10 days time, so hurry with your votes.

Tags: , , , , , ,
Posted in Looking Forward | Comments Off on Marc Faber: Asset Markets May Rebound Within 3 Months

Should value investors be ‘bullish’ in a bear market?

Tuesday, July 15th, 2008

Some of you may have subscribed to value-oriented stock research newsletter. One thing you may notice is that as the market enters deeper into the bear market, the number of “Buy” recommendation increases. From that perspective, these value-oriented stock research are ‘bullish.’

Before we comment on the wisdom of their recommendations, we will have to explain the philosophy of value-oriented stock research. As we explained to one of our reader’s comment in Confidence back? Beware of bear market rally,

… for long-term value investors, they follow the ?bottom-up? approach. That is, they (i.e. the value investor) invest in businesses based mainly on its individual merits (i.e. is it a good solid long-term safe businesses whose stock price is undervalued? Bear Stearns is definitely ruled out in this case) and not worry about the macroeconomic big picture, the business cycle, e.t.c. … In that sense, such value investors are neither ?bullish? or ?bearish.? Rather, they have a neutral view on the business cycle and other macroeconomic big-picture.

Here, we see a potential trap for the unwary value investor. Back in February last year, as we explained in What to avoid at the peak of the business cycle?,

One of the common mistakes that novice investors often make is to extrapolate the past earnings of cyclical stocks into the indefinite future during the turning points of the business cycle. Since the stock market always anticipates the future earnings of companies, cyclical companies will look ?cheap? (i.e. low P/E ratio) during the peak of the boom.

During the turning point of the business cycle, the P/E ratios of good quality companies in a bear market may look very enticingly cheap. But as we explained in Why accumulating stocks on the ?cheap? can be deadly to your wealth?, during such a time,

… a falling average P/E ratio does not imply that stocks in general are cheap. Yes, with careful and judicious stock picking skills, you may be able to find really cheap stocks. But do not let falling average P/E ratio fool you.

Low P/E plus the “Buy” recommendations from the value-oriented stock research may make buying stocks of good quality companies look like astute contrarian moves.

But this is where the Achilles? heel of value-oriented stock research lies. Because they hold a neutral view on the macroeconomic big picture and business cycle, they can severely underestimate the effects of a protracted downturn in the earnings of businesses. This news article, Bottom-up analysts ignore the big picture, sums it well:

“You have got a set of numbers that assumes some sort of recovery,” Macquarie’s equity strategist, Tanya Branwhite, said when releasing the report. “Unfortunately, that’s premised on the cycle we have seen in the last five to 10 years. What is facing the economy at the moment is nothing like we have seen in the last five to 10 years.”

One value-oriented stock research (which we will not name) believes that this current bear market will be like any other ‘typical’ bear market in the past- the downturn will last only 12 to 18 months. In other words, their position is that this coming recession will only be a V-shape or U-shape recession (see What type of recession is coming?). If they are wrong about that (i.e. the coming recession is an L-shape one), then their current “Buy” recommendation will be very wrong.

To illustrate this point, we will give you two examples.

After the stock market crash of 1987, the world economy did not fall into a Depression as initially feared. By 1989, stock markets had more or less recovered. If you bought into the market after the crash, you would have profited greatly.

But what if you bought into the market after the stock market crash of 1929 (see The Great Crash of 1929)? Or you bought Japanese stocks just after the bursting of the bubble in the late 1980s? The outcome will be completely different if you had done so.

In short, not all bear market purchase will turn out to be astute if the timing is way too early.

Tags: , , , , , , , , , , , ,
Posted in Investor Education, Looking Forward, Value Investing | 6 Comments »

Why are fantastic stocks sold off in a bear market?

Friday, March 28th, 2008

We are now officially in a bear market for stocks. As of yesterday, the Australian All Ordinaries Index had fallen 21% from its 1 November 2007 high. At its lowest point in 18 March 2008, the index was down by 25%. Right now, the All Ordinaries Index is even lower than what it was 12 months ago. Not only that, the market is getting more volatile, with stock prices falling very rapidly (e.g. the infamous Black Tuesday happened in January 2008 when the Australian market fell by 7% in one day). For investors, there seem to be no place to hide in the market as it seems that almost every stocks are affected.

Contrarians such as value investors would love such a bear market because it is a great time for bargain hunting for good quality stocks. For this reason, they are often inaccurately misunderstood as ‘bullish’ as they get excited and greedy when the market as a whole is getting fearful. But this leads to another question. In a bear market, especially during times of panic selling, why would stocks of good quality businesses fall along with the bad ones? If good quality stocks are really that good, why would they fall in the first place?

The most common cited general answer to this question is that in a panic, animal spirits of fear takes over and the market as a whole becomes irrational. In other words, it is negative sentiment that drives such absurdity.

But we are not satisfied with this answer, for it sounds like a cliché to us. So, for those who are as dissatisfied as us, we will provide one of the many pragmatic reasons for such absurdity. One word sums up this reason: leverage. Today, there are so much leverage in the financial system and by extension, the market. Both retail and institutional market participants borrow and employ leveraged derivates (e.g. options, CFDs, futures, etc). The problem with leverage is that, when the market goes against you, your losses are magnified and you find that you are suddenly short of cash (to repay the debts, obligation, margin calls, collateral, etc). Sometimes, the only way to increase your cash level is to liquidate whatever you have- the good investments along with the bad. If enough people are in the same situation as you, this will result in widespread indiscriminate selling in the market.

Thus, weak hands’ forced liquidation due to de-leveraging results in indiscriminate selling. For those who are in a strong cash position, this can be an opportunity to exploit.

Tags: , ,
Posted in Investor Education | 4 Comments »

Confidence back? Beware of bear market rally

Monday, March 24th, 2008

Last week, gold prices fell from a high of around US$1020 to around US$910 at the time of writing. Oil prices fell from a high of around $US110 to around US$100. Commodities from copper, zinc, nickel, wheat to corn also fell suddenly. The US dollar then rallied.

What is going on? Is inflation suddenly being suppressed and confidence in fiat money (chief among them is the US dollar) revived? The financial media even joined in the cheer-leading, as we see this nonsensical article from Bloomberg: Commodities Drop, Rally in Dollar, Stocks Vindicate Bernanke– it said,

The biggest commodity collapse in at least five decades may signal Federal Reserve Chairman Ben S. Bernanke has revived confidence in U.S. financial firms.

…

Investors who had poured money into gold, oil and corn, seeking a hedge against inflation and a weak dollar, sold commodities to raise cash or buy stocks.

So, this article is saying that in the span of less than a week, confidence is being revived and returned into the global financial system? Is it implying that ‘investors’ are suddenly seeing the light at the end of the tunnel and raised cash to buy stocks in anticipation of the glorious economic recovery that Bernanke is going to orchestrate? Indeed, this article should be put into the humour section.

One common explanation of such a sudden fall in commodity prices is that ‘investors’ have to liquidate their winning trades (e.g. gold, oil) to fulfil the margin call of their losing trades (e.g. stocks). Another way to look at this is that this is an example of deflation. Anyway, whatever the reason, we are hardly surprised by such developments. Our loyal readers should not be surprised too because we have warned about it even as early as 12 months ago (see Inflation or deflation first? and Warning: gold price can still fall significantly).

Anyway, do not be fooled, dear readers. This is a great example of a bear market rally. Such rallies are very common- even in the Great Crash of 1929, the stock market rallied for 6 months in 1930 before falling to its lowest point in 1932 (see Second lesson of ?29 crash?bear rebound).

In the next article, we will explain why such kind of price fluctuations happens, which should not perturb the long term investor. Keep tuned!

Tags: , , ,
Posted in Market Observations | 6 Comments »