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Monday, 23 February 2009
Has Wall Street capitulated yet?
Selling into strength is still very much the best way to preserve capital and for many more months, forget about buying and holding, at least until Wall St crashes.
Apart from recommending readers to only selectively buy the dips and to immediately sell into strength, this column has for many months warned that Wall Street, the source of the world’s problems, is hugely overvalued and that unless it suffers a full-fledged capitulation, there can be no bottom in sight for global equities.
In our Nov 17, 2008 column (Until Wall St capitulates, best to sell into strength), we cautioned against unwarranted earnings optimism among US analysts insofar as earnings estimates went, and said that it is not unreasonable to expect US stocks to fall at least 50 per cent from all-time highs, given that markets all over the world had by then already lost more than 60 per cent.
At that time when the Dow Jones Industrial Average was at 8,500, our forecast was that it should drop to around 7,000 before there can be any talk of the US market having capitulated.
Given that the Dow closed at 7,365 on Friday (its intraday low was 7,249) can it be argued that Wall St has finally thrown up its hands in surrender and if so, might a bottom have been reached?
Before going further, it’s worth emphasising a few important points that seem to have escaped many observers.
First, the arrival of a bottom does not automatically signal the start of a bull market. Stocks can drift for years within bands before breaking out so it would be a mistake to equate the two.
Second, many expert observers have based their ‘bottom’ or ‘buy’ calls using traditional indicators like the VIX (volatility of S&P 500 options) or book value or earnings per share and benchmarking these against history.
We have argued many times before that these comparisons are not appropriate because this crisis is historically without precedent - when for example, was the last time that the world saw European nations go bankrupt?
Third, the efficiency of the market. All valuation metrics (as brokers like to call them) are based on the notion that the market is efficient (some rely on returns falling within a normal distribution or bell-shaped curve) when in reality it is not.
There is inherent bias to the upside in the majority - though not all - of broking firm reports. Chinese walls are typically only for show and prices have been supported by the naive belief that the US government, Treasury and Federal Reserve can print enough money to refloat the system again (though this last point is being seriously questioned by the market now).
If the market is actually inefficient, if risks are systematically understated by most brokers (and politicians and central bankers) and if prices are artificially supported by hopes of government bailouts, the conclusion has to be that avoidance is the best and most prudent option for the time being.
As for Wall St, when we made our ‘Dow 7,000’ forecast three months ago, we envisaged the index falling to that level in a few days, since ‘capitulation’ is equated to a sudden, large blowout of maybe 10 per cent in one session.
The fact that it took the Dow about 13 weeks to lose 1,135 points or 13 per cent (an average of about one per cent a week) would probably not qualify as a full-fledged, panic-stricken selloff. Recall for example, that on Oct 19, 1987, the major US indices crashed almost 20 per cent that day.
As a result, we do not think that the US market has seen the worst yet, which by extension, means the same for the rest of the world. Where might Wall St’s bottom be?
We honestly don’t know, but we do know that if the all-time highs reached in 2007 were founded on flaky economics peddled by shady investment bankers, then using those levels for comparison today might be unjustified.
The conclusion therefore remains the same - traders have to be very short-term in their approach to this market and not over-commit themselves if they decide to buy the dips.
Selling into strength is still very much the best way to preserve capital and for many more months, forget about buying and holding, at least until Wall St crashes.
1 comment:
Has Wall Street capitulated yet?
By R SIVANITHY
23 February 2009
Apart from recommending readers to only selectively buy the dips and to immediately sell into strength, this column has for many months warned that Wall Street, the source of the world’s problems, is hugely overvalued and that unless it suffers a full-fledged capitulation, there can be no bottom in sight for global equities.
In our Nov 17, 2008 column (Until Wall St capitulates, best to sell into strength), we cautioned against unwarranted earnings optimism among US analysts insofar as earnings estimates went, and said that it is not unreasonable to expect US stocks to fall at least 50 per cent from all-time highs, given that markets all over the world had by then already lost more than 60 per cent.
At that time when the Dow Jones Industrial Average was at 8,500, our forecast was that it should drop to around 7,000 before there can be any talk of the US market having capitulated.
Given that the Dow closed at 7,365 on Friday (its intraday low was 7,249) can it be argued that Wall St has finally thrown up its hands in surrender and if so, might a bottom have been reached?
Before going further, it’s worth emphasising a few important points that seem to have escaped many observers.
First, the arrival of a bottom does not automatically signal the start of a bull market. Stocks can drift for years within bands before breaking out so it would be a mistake to equate the two.
Second, many expert observers have based their ‘bottom’ or ‘buy’ calls using traditional indicators like the VIX (volatility of S&P 500 options) or book value or earnings per share and benchmarking these against history.
We have argued many times before that these comparisons are not appropriate because this crisis is historically without precedent - when for example, was the last time that the world saw European nations go bankrupt?
Third, the efficiency of the market. All valuation metrics (as brokers like to call them) are based on the notion that the market is efficient (some rely on returns falling within a normal distribution or bell-shaped curve) when in reality it is not.
There is inherent bias to the upside in the majority - though not all - of broking firm reports. Chinese walls are typically only for show and prices have been supported by the naive belief that the US government, Treasury and Federal Reserve can print enough money to refloat the system again (though this last point is being seriously questioned by the market now).
If the market is actually inefficient, if risks are systematically understated by most brokers (and politicians and central bankers) and if prices are artificially supported by hopes of government bailouts, the conclusion has to be that avoidance is the best and most prudent option for the time being.
As for Wall St, when we made our ‘Dow 7,000’ forecast three months ago, we envisaged the index falling to that level in a few days, since ‘capitulation’ is equated to a sudden, large blowout of maybe 10 per cent in one session.
The fact that it took the Dow about 13 weeks to lose 1,135 points or 13 per cent (an average of about one per cent a week) would probably not qualify as a full-fledged, panic-stricken selloff. Recall for example, that on Oct 19, 1987, the major US indices crashed almost 20 per cent that day.
As a result, we do not think that the US market has seen the worst yet, which by extension, means the same for the rest of the world. Where might Wall St’s bottom be?
We honestly don’t know, but we do know that if the all-time highs reached in 2007 were founded on flaky economics peddled by shady investment bankers, then using those levels for comparison today might be unjustified.
The conclusion therefore remains the same - traders have to be very short-term in their approach to this market and not over-commit themselves if they decide to buy the dips.
Selling into strength is still very much the best way to preserve capital and for many more months, forget about buying and holding, at least until Wall St crashes.
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