Sunday, November 30, 2008
- The S&P 500 rallied 19% in just five trading days, its best-five day rally since 1933. Periods of rally during bear markets are common; we have seen six such rallies (of obvious lesser magnitude) in the last fifteen months.
- This particular rally is important not only in terms of magnitude, but because volume and breadth has been more impressive than the previous six. This rally could carry the S&P 500 up another 15% to 1,050-points (a level of resistance that would attract considerable supply).
- Rallies of any nature, but especially ones of such enormous gravitas, can play on an investor’s emotion and, rightly or wrongly, pull them into the market without sufficient evidence that a lasting bottom has been made and that the beginning of a new multi-year market has started.
- Bear markets very rarely make V-shaped bottoms and instead bear market bottoms are typically processes that take months to accomplish and usually revisit the lows. So even if the recent bear market low has been made and this rally does ultimately advance the market forty percent from those lows (bringing the S&P 500 up to 1,050 points), it is probable that we will have an opportunity to, once again, buy stocks closer to those levels – but doing so as investors and not as speculators.
Bear Market Rally Quotables
- ”I have no idea when the next bull market starts, but I do think we are setting up for the mother of all bear market rallies.” – Barton Biggs of Traxis Partners, November 25, 2008 in Financial Times
- “To be certain, the market became oversold enough last week to experience a rally into this week’s expected light-volume Holiday trading and then into December. It would not be unusual at all in the course of a bear-market to see a 2-month, 20% rally; they are quite common and could push the S&P 500 back up to nearly 900-points by the end of the year.” – Allen Harris on November 23, 2008 on www.BerkshireMM.com
- “Bears agree on the rally, but not the follow-up. Here’s what they say:
- there will be a rally
- you will get sucked in
- you will get crushed
- in 2009, you will work in a taco stand.”
- Bob Pisani of CNBC, November 26, 2008
Keeping an Open Mind
The S&P 500 rallied 19% in just five trading days, its best five-day rally (I can’t believe that I’m about to say it) since the Great Depression.
Is this the beginning of a new multi-year bull market? Or, to paraphrase Bob Pisani, will this just be a sucker’s rally that will crush investors who jump from being risk-averse to being risk-seekers as they agonize over the thought of being left behind?
To best answer this question it is important to have an open mind and not stay too attached to just the bullish or the bearish view. That sounds obvious, but that is not always the case. Not only are there perma-bears and perma-bulls who only give a bearish or bullish outlook, respectively, at any (and I mean any) time, there are smart people whom even during the most bullish of bull markets can find enough information to build what appears to be a very bearish case. Conversely, bulls can selectively find information and historical data to support a bottom in even the most difficult bear markets.
How can that be? Because, unfortunately, it is impossible to pull together all of the global financial markets’ moving parts (money flows, credit availability, exchange rates, economic stability, sentiment, known and unknown financial stimulus and government intervention, earnings, etc.) to fully encapsulate all the factors affecting financial markets into any certain forecast, bullish or bearish. That is why it is important to keep an open mind about all possible outcomes including outcomes which are contrary to your very own view of the world (I think you know by the three “Bear Market Quotables” how we feel – we are in a bear market until proven otherwise).
During a bear market it is dangerous to become blindly bearish. As such, we are open to the possibility that this magnificent rally may actually become something more substantial. However, without further evidence that this is the beginning of the next multi-year bull market then it is sheer speculation (as opposed to investing) to jump from being risk-averse to being a risk-taker. Being a speculator includes trying to jump in and out of bear-market rallies – even if it is going to be the Mother of all Bear Market Rallies.
A Very Biggs Rally
For the record, the type of bear market rally that Mr. Barton Biggs was writing about is something akin to the 40% rally of 1929. That type of rally clearly is not out of the question. The S&P 500’s low was about 750-points; a 40% rally would the index to 1,050-points. That is about the recent high on October 14th following the October 10th waterfall decline. That’s an additional jump of about 15% from current levels. That’s amazingly impressive, but not something an investor should chase.
In Mr. Biggs’ Financial Times article he does extend the caveat that this year his investments as a hedge fund manager “have been wrong on the severity and duration of this panic.” Since the biggest and the brightest names have lost half of their money this year that does not necessarily exclude us from listening to his tenured input. Among the reasons he cites for such a massive rally is that while “no one knows what levels of pessimism were necessary to spawn the forty percent 1929 rally…I’ve never seen capitulation and despair like this.” Mr. Biggs also reminds us that “stock markets have been obliterated and are deeply oversold…we should be due.”
And due we are. Certainly that type of comment is far from scientific, but investing in the stock market has never been an exact science. Still though, the question is whether or not that type of move is sustainable for the long-term and it is that very question to which Berkshire Money Management will maintain open mind. Yes we are looking for evidence of a new and durable bull market as opposed to crossing our fingers and jumping in.
The economy alone is a good reason for us to be cautious but so, too, is the fact that recovery rallies after climax selling are usually temporary. Even if the lows for this bear market have been set, those lows are part of a longer-term consolidation pattern that may last months and make or match new lows before a sustainable uptrend can develop. In other words, even if 750-points on the S&P 500 is the final low for this bear market, we will very likely have a chance of seeing similar lows again in the months ahead.
Evidence versus Emotion; Investing versus Speculating
Recently, on November 19th and 20th, we saw a series of two 90% Downside Days (down-volume equaled 90% of total volume), quickly followed by a 90% Upside Day (up-volume equaled 90% of total volume) on November 24th, and a second such Upside Day was recorded on November 26th. History continues to argue that the final bottom of this bear market will most probably be accompanied by several 90% Downside Days followed quickly by a 90% Upside Day. As a result, this pattern should never be ignored.
However, while this is potentially very bullish (for both the shorter- and the longer-term) we have discussed the importance of having an open mind when it comes to being bullish or bearish. The kind of moves we have seen in the market in the last week as well as the kind of moves we may see over the weeks to come will tempt us to jump back into the stock market and will certainly suck in many investors and traders. We need to be careful that we make moves based on facts, not on emotion, lest we not only get sucked in, get crushed, and end up working in a taco stand in 2009.
During extended bear markets, periods of rally are always tempting to investors to jump back into stocks too soon. Over the past fifteen months, we have seen at least six occasions in which a series of two or more 90% Downside Days were quickly followed by one (and sometimes two) 90% Upside Days. As mentioned above, based on past experience with identifying bear market bottoms, this pattern should always be viewed as a potentially significant development. But, in the spirit of keeping an open mind, we must remember that each of those 90% Upside Days was, at the time, heralded by many as the start of a new bull market. One such rally, starting in March 2008, lasted two months. The remainder lasted from several weeks to a few days. Most were followed by sharp declines that quickly wiped out much of the earlier gains. Thus, each of those rallies proved to be a better opportunity to sell stocks into strength, rather than to buy.
It will be essential under prevailing conditions to look for additional confirmatory evidence that the desire to sell (supply) has been exhausted and buyers (demand) have begun to enthusiastically accumulate a broad cross-section of stocks. It is these factors that will help distinguish between another temporary rally within a continuing bear market, and the start of a broad, sustained market advance.
Bottom Line: We continue to believe that this is a bear market until proven otherwise and that it continues to be important to play defense; discretion remains the better part of valor. However, we acknowledge that we are close to the bottom of this bear market in terms of magnitude, if not duration. As such, we are open to changing our defensive stance to something more bullish should the evidence (and not the emotion) dictate to do so. It was important not to let emotions get the better of us during any of the half dozen previous bear market rallies we have gone through over the last year or so. It will be particularly important for this latest rally as it could very well be the Mother of all Bear Market Rallies and could push the S&P 500 up to 1,050-points.