The perils of prognostication - a missive turning point
September 1, 2003
The world renown, much anticipated, commonly misunderstood, yet well-appreciated, missive de Duru a la Wall Street has reached an interesting turning point. I started off writing these things as an outlet for my frustrations with the stock market culture back in 2000. It then blossomed into my personal soap box railing against the consensus opinion that was encouraging people to keep losing money in the bear market. With the economy finally stabilizing (apparently), and the bear market reaching its late innings, a few of my pegs for being contrary are slowly eroding. I also feel my standpoint and opinions have been stated often enough to at least be understood, even if not agreeable to everyone. So bear with me during these next few months as I try to figure out what, if anything, I should continue doing with these things.
In the meantime, I thought an extended market missive would be quite appropriate on the eve of the all important day after Labor Day day of trading. I will extend an earlier missive reviewing where I think everything currently stands and also add some more color to the post-Labor Day trading phenomenon. Finally, I will talk a little about the perils of prognosticating.
*Labor Day madness
Since Labor Day is almost ending, let's start with it. In an earlier missive I recommended reviewing a study I did in September, 2002 on the behavior of the market after Labor Day, but I neglected to provide an update for 2002. True to form, the post-Labor Day trading revealed the kind of market that existed at that time. Last year's events were particularly extreme. The day after Labor Day, 2002, the S&P 500 dropped an ominous 4.2%. After the market regained its balance and recovered those losses in a little over a week, a steep sell-off ensued that culminated in a particularly ugly September sell-off that shaved 12.4% from the S&P 500. I am guessing that is one of the worse Septembers on record. The selling continued into October, but bottomed out there. By the end of that month most of the post-Labor Day losses had been recovered. The extremes of this time, and the rapid recovery, hold some significant lessons of what we might expect going forward.
First, all the extreme selling we saw in July and October of 2002 and finally in March of 2003 washed out a lot of negative sentiment from the market given the close proximity of all that pain. In aggregate, the cleansing was so thorough that as yet another bear rally took off from the March lows, the consensus market opinion was pretty negative and remained negative for quite some time. Only NOW (perhaps over the entire summer) has the consensus started to warm up to the market. On the other hand, the rapid recoveries from each of these lows has allowed the true-believers to maintain their faith in the resiliency and positive power of the market. As we now sit with a far over-valued market, the battle between the skeptics and the optimists should reach a fevered pitch over the next two months. As I suggested last time, we are now either poised for another powerful leg up on the markets or a rapid sell-off - it is far from clear how long either one will last or how far they will go. There are a lot of factors that we need to see play out, but a lot depends on how much buying power the "performance-chasers" bring to the market (more on this below).
Now of course "past performance is not a guarantee of future results," so there are no guarantees that post-Labor Day trading is going to be indicative of anything. The statistics around this are what we call market seasonal or cyclical tendencies and tendencies are not guarantees, just what is most likely to happen. No matter your investing style, it is important to at least be aware of these things in case you find it applicable to your current situation (such as timing of investments or withdrawals of monies). Combine these tendencies with the specific circumstances of the moment, and you might come up with some revealing insights. For example, the "sell in May and go away until Fall" adage seems like it may not work this year. Why? The rally leading into May was so strong that formerly skeptical professional managers and other institutional investors/speculators were caught flat-footed and lagging the market. Many were forced to keep trading into the summer to try to catch up in performance. This performance-chasing is clearest in August where the indices rebounded nicely from the lows of the month. Although the market has had every reason to go back down to more reasonable valuations, these performance-chasers have been compelled to buy these dips and thus keep the market afloat. The chasing has been most pronounced on the Nasdaq as it is most prone to the speculative excesses that produce over-valued stocks and the maximum pain for those making bets against the market. But do not forget that the period the "sell in May" adage applies to is NOT over! The "cease and desist" order extends through September and October - we still have two more months to go. If these big money players start fearing losses more than they fear missing the next rally, watch out below. These guys pay attention to history, cycles, and statistics and right now history tells these folks that Sept and Oct highs mark excellent points for extracting profits from the market.
Speaking of adages and statistical reference, here are some more that are probably at work as we speak: "The market has only been down four years in a row ONCE - that was during the Great Depression." "The market typically goes up in the year before a presidential election" (makes great sense, right?). It sure looks good on paper!
While we have seen the market drop from wildly over-valued, we have YET to see the market swing to extremely under-valued. This is a tribute to the fundamental belief in the market that remains. This faith is not to be under-estimated and can still be gamed for profit for those with a keen sense of timing. But I continue to believe that the market is gradually cycling to shake this faith to the point that it DOES get under-valued. Ultimately, valuation wins in the end - every bubble in history has proven this out. An economy cannot sustain prices in excess of asset value forever. I suppose at best, we can expect the market to churn about until the economy catches up to the market valuations (this would play into the decade long trading range theory).
If we assume that the economy has seen the worst for now, or at least no big calamities are ahead of us, then it is probably safe to maintain a buying bias in the market. What I mean specifically is that periods of deep weakness should be bought. This should even help those who want to stick to a buy and hold strategy; hopefully in the coming 10-20 years the market will be high enough to make such risk-taking worth it. I am certainly not one to hold to this strategy for now though. At most, I like "buy and hold for a while." In addition, until the economy gets back on a track that creates jobs and increases the wages of those holding jobs (when was the last time YOU had a raise?!?), excessive valuation in the market should be sold on a consistent basis to lock in some or ALL profit. I know I have talked on this theme so much that I should be blue in the face by now, but I just know that the market is ruled by greed and fear, and we are at a point where it is easy to get used to the success of greed.
*The perils of prognostication
My review of what I wrote about Labor Day trading got me to think a little deeper about the direction and use of these missives. My record of calling the general market trends "pretty well" has been largely a function of the incessant downward trend of the market and the constant refusal of the optimists to recognize just how bad the market was. Under such conditions it is not hard for a contrarian-like person such as myself to keep ringing alarm bells that prove prescient. Even my switch to buy into the recent rally was more predicated on my decision not to miss another clear bottoming event in the market; I cannot imagine these bottoms will continue to be so clear. Regardless, now that the downtrends in the Nasdaq and the S&P 500 have been broken (amazingly, the Dow is STILL in a downtrend that began around 1999), things can only get more difficult to call and more tricky to guesstimate. We are churning and the market could spit up or down --- and for reasons that may only be clear in hindsight. This means that my missives are less likely to be helpful in a general sense.
The market is under-going some kind of transition: it can take all sorts of paths to get to where ever it is finally trying to get to. Any prognostication about where we go next is then going to have a decent-sized margin of error. Since I cannot quantify the probabilities on these prognostications, you will have less guidance for action during this transition period. (I think that followers of technical analysis will be the most highly-equipped to deal with this transition).
I can only hope I can continue to provide sound reasoning for my prognostication on where we are headed next, but therein lies the peril. I can be wrong on either or both the fundamentals in the market or the market's response to these fundamentals. This peril of course has always existed. But as things become more uncertain, it becomes all too easy to continue to project past behavior and events into the future. Talk about peril! For those of us who are trying to tap dance around the madness in the market, quick reactions will be the course of the day. These missives are not constructed around such rapid response. In fact, even in the past month as I finally turned outright bearish on the market, I have continued to find individual opportunities that had to be seized. All I can do now is to remain extremely humble about all the ways in which I can be proven wrong and hope that something I have to say will help someone somewhere. For you the reader, the choice is not easy if you are trying to find guidance. As uncertainty increases, it is easy to accept everything carte blanche or to reject everything right out of pocket - it is much more difficult to come up with filters that allow you to apply the information and knowledge in these things to your specific situation. I wish I could help more, but I am not a registered and certified financial planner! (=smiles=)
So what specifically to do now? Since I have done enough alarm-ringing, I think it would be more useful to focus on the opportunities (long) in the market. The growing stabilization in the economy has ushered forth numerous prospects in the past year or so - even when the overall market did not seem too healthy. I purposely avoid talking about specific stocks in these missives (and rarely refer to specific sectors outside of technology), so I am not yet sure in what form I might discuss these opportunities. I will continue to banter about these on an individual basis with those of you interested in such stuff, but I am not yet interested in publishing these things in any official form (again - talk about peril!). But never fear. The moment I sense a rising consensus that seeks to lead the masses to massive monetary misfortune in some modern manner, I will not hesitate to speak up!
In the meantime, I am certainly open to suggestions for where to go next. Regardless of where we do go from here, just remember to....be careful out there!