is really about risk management. When the odds are favorable, you expose some
of your capital to the risk of loss in search of possible gains. The best
time to invest is when both the technicals (charts) and fundamentals
(valuations, future earning potential, etc.) are favorably aligned. There has
never been and there never will be a time where the techncials and
fundamentals are perfectly aligned, which is another way of saying there is
always some form of risk in any financial market. It is simply the degree of
risk which fluctuates.
The Market Looks Forward
not surprise anyone if we saw negative GDP (economic) numbers for the next
three quarters (Q3 2008, Q4 2008, and Q1 2009). Things look and are
Housing is still a mess.
Banks still have problems to deal with.
Americans have seen their wealth decline via housing and stocks.
Credit default swaps (CDS) market remains a threat.
The deleveraging process is not over.
time the U.S. posted three consecutive quarters of negative GDP growth was
during the 1973-1974 bear market. GDP numbers are released over time, but
basically have a one quarter lag. For example, the final 3rd quarter GDP
numbers for 2008 will not be released until December 23, 2008. Here are the numbers
Q3 1974 -3.8% (known in late Q4 1974)
Q4 1974 -1.6% (known in late Q1 1975)
Q1 1975 -4.7% (known in late Q2 1975)
Q2 1975 +3.0% (known in late Q3 1975)
think stock investors did poorly between the start of Q3 1974 and the end of
Q1 1975 since the economy and social mood were less than stellar. Since the
markets had already fallen significantly (sound familiar) in anticipation of
the coming economic weakness, an investment made in stocks in Q3 of 1974 was
quite profitable. From the bottom made on October 2, 1974, the S&P 500
gained 30.84% during the next year. The point is the markets bottomed well
before the economy. It goes without saying 2008 is quite different from 1974,
but the concept of markets looking forward will apply at some point during
this bear market.
Headlines Will Continue To Be Worrisome
need not wait for the headlines to become more positive before allocating
some of their capital to stocks. The headlines below were on the front page
of major U.S. newspapers between late September 1974 and late March 1975. Stocks
bottomed on October 2, 1974, which means while the headlines were still very
negative, stocks were looking forward to better times.
Nixon's Chief Aids Go On Trial
Ford's Ban on Wage and Price Controls Draws Criticism
Tapes Open Pardon Question
Oil Nations Warned
Fed Pledges End to High Interest Rates
Senate Joins Efforts to Get Nixon Tapes
Ford Defends Action, Made No Pardon Deal
Stop School March
Hold French Embassy
Escort School Buses
Nixon Likely to Resign From Bar
May Pardon Others
Energy Taxes Next?
West Must Change Ways, Iran Warns
Opposes Gas Tax, Rationing
U.S.-Soviet Talks Fall Apart
Tax Hike Heads New Ford Plan
Crisis to Change Americans
President Hopes to Cut Inflation by Next Year
Tapes Reveal Nixon Knew Facts Early
Billion OK'd For Housing Aid
Ford Says He Will Prove Polls Wrong
Boosted in '75 Cars
at Watergate Trial
Ted's Night of Anguish for Mary Joe
Index Takes Plunge
U.S. Investigates Food Price Fixing
Rate HitsThree-Year High
Pleads for Inflation Fight
Crisis Faces Sympathy
Strike Seems Inevitable
Stores Ask Voluntary Rationing of Sugar
State Shooting Guardsman Acquitted
Dies in Shootout
More Autoworkers Jobless
Hold off Executions
Hits Auto Plants
May Halt December Production
and Hush Money
Threat of Gas Lines - We're Using Too Much
U.S. Economy Flashes New Distress Signals
Accused of Mortgage Bias
Case Goes to Jury
Economic Plan Pledged
$16 Billion Tax Cut
Oil Price Batter Balance of Trade
Jobless Forecast Grim
Funds Low, Projects Cut
Unemployment Hits California
U.S. Rolls of Unemployment Climbs to 8 Million
Works On Hearst Case
expect the headlines to look quite bleak in the coming quarters, but we must keep
in mind that it is not unusual for stocks to bottom well before the economy
and social mood. An investor who held stocks while the headlines above
appeared in his daily paper was rewarded with a nice profit.
Signs - Maybe Something To Build On
The stock market already knows GDP numbers are going to be weak
in the coming quarters, which is a big reason stocks are down roughly 40%
from their all time highs.
While valuations could get more attractive, they are currently
near 18 to 25 year lows.
Investor and public sentiment is extremely pessimistic (a
The VIX ("fear index") is near all time highs (a
The number of new highs vs. new lows made on the NYSE last
Friday was off the charts bearish, showing a very strong desire to sell
stocks at any price (which can be bullish for the future).
The October 10, 2008 lows held up during last week's retest.
Thursday's close was impressive and came on strong volume.
Stocks made money last week.
LIBOR has come down indicating some improvement in the credit
and Hussman Say Now Is The Time
must understand even the best of the best cannot pick market bottoms, both
Warren Buffet and money manager John Hussman say now is a good time for
investors to begin moving slowly off the sidelines (assuming you currently
have a large cash position). In today's New York Times, quoting Mr. Buffett:
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."
Buffet opinion column is here (NYT).
manager John Hussman posted this comment on his website on October 15, 2008:
at these levels may find themselves scrambling to repurchase stock as that
occurs, particularly in view of current valuations (even adjusted for the
impact of an ongoing recession). On nearly every measure - sentiment,
valuation, volatility, oversold conditions, and others, we are observing
extremes associated with strong expected return/risk profiles, on average. Again,
we retain put option coverage, now in-the-money, in the event that the market
continues lower. However, my impression is that investors underestimate the
potential for a very rapid 20-25% market advance as risk aversion
Knows What The Future Holds
have proven time and time again that those who are willing to buy when
valuations are low and the outlook is bleak have been rewarded with profits. All
we can do is assess probabilities based on what we know today. Even with
favorable odds, we can get negative outcomes, which is where risk management
comes into play.
Stocks Go Lower? Absolutely, Yes
valuations look better than they did a year ago since stock prices have come
down. Do valuations alone mean it is time to abandon risk management and/or
invest all your cash? No. It is still prudent to maintain a very large cash
position. It is also prudent to use some type of downside protection or
hedging, which we have mainly in the form of put contracts. If we dip our toe
into the water and are unsuccessful, we will remain patient while still
holding a large cash position. If the market starts to become profitable from
here, we will consider our options based on the information available at that
time. A measured, gradual approach will enable us to manage risk. If it seems
totally unbelievable that now may be a good time to invest, then it probably
is a good time to invest for the longer-term. The best opportunities will
come when people are most fearful and pessimistic.
Saying The Bear Market Is Over? Only Time Will Tell
the context of a secular (long-term) bear market, cyclical (shorter in
duration) bull markets will occur. The duration of the cyclical bull market
can be months or years, which is another reason to keep an open mind about
the possibility of stocks performing better than most would believe in the
coming weeks and months.
market never makes it easy. This time will be no different. It will never
feel comfortable to invest after a 40% decline. However, it is prudent to
have a plan in place should the markets surprise on the upside in the coming
months. We have such a plan, which manages risk. You should never come to the
markets with a blind bullish or bearish bias. I understand and respect the
risk that remains in this market, especially related to the process of
deleveraging. However, I also understand what is happening now in the context
of past bull and bear cycles.
Ciovacco is the Chief Investment Officer for Ciovacco Capital Management,
LLC. More on the web at www.ciovaccocapital.com