When Markets Are Underestimated

I know that Yahoo Finance's Tech Ticker is followed by a lot of people, so the videos that appear there may not be anything new to you. But I tend to take note of the videos with the more unique and best-defended viewpoints... and given the pessimism in the markets out there, these are mostly the bullish viewpoints, since they are the hardest to reason out at this point.

Don't want to believe that the bullish case is still the contrarian case (and I mean major contrarian) even after this 50% rally in markets? Just check out the comments section of this video, where Jeff Matthews is being interview by the infamous Henry Blodget. Matthews talks about how so many people have missed this rally and how a "recovery can mirror a decline", especially when a recovery is so underestimated.

To restate the what I call the five stages of "envious greed":

First, they denied that a recovery was going to happen anytime soon. Then they lashed out with anger at those who spotted signs of the recovery. Now, they’re bargaining, admitting the existence of the recovery that they did not see coming, but belittling it. Next, as things keep improving, we can expect them to get depressed. We don't expect acceptance to fully set in until late next year.

I also like it when Blodget and Matthews talk about the "Grumpy Analyst Syndrome". I think its not just the analysts who missed calling the rally and are grumpy right now. The problem is that most people take the stock market as an ego thing... to the extent that they ignore what the market is telling them. It is so important for them to be right that they miss the real picture.

Here is another good article on what we now know as G.A.S., also by Jeff Matthews.

I think so many people have missed this rally that they are "rationalizing" their non-participation, rather than "internalizing" what is happening to the market.

Finally Matthews also talks about how inventories can get so low, that is the business overshoot to the downside when cutting down inventories and costs, that the snap back to the upside can be vicious. I also talked about this in my previous post: Revenue Growth The Next Catalyst.

Anyway, enjoy the video!

Comments

[Nick36:]

When the rally isn't based on fundamentals. Then for prudent investors it's better to miss it than to participate in it.

Warren Buffett sat out the tech rally in the late 1990s. And although many people scoffed at him at the time. He was proven right when Nasdaq eventually plunged some 88% from its top.

It's no use to feel rich on your paper wealth for a couple of years and then find yourself in the poor house eventually.

The reported P/E of S&P 500 is now 129.19.
www2.standardandpoors....

And at this P/E, any stock market rally is purely a speculative rally that predicts a very bright future that's unlikely to come about. Earnings can improve but not 800% within a space of a few months. And only this kind of improvement in earnings will bring the reported P/E of S&P 500 down to a historically reasonable value of 16 at present stock prices.

It's true that there is no limit to how high stock prices can go. During the dot com mania many internet companies that never made any profits ended up being valued millions and even billions of dollars.

But these stock prices are an illusion of wealth and not real wealth. It all depends on false perception and some deception by professional Wall Street hacksters. And as soon as their latest Pyramid Scheme is discovered. This illusion of stock market wealth quickly disappears into thin air.

When the stock market rally is based on optimistic stories about a bright future rather than on present reality. Then participating in this rally is no better than gambling. And perhaps its even worse than gambling. Because a lot of these optimistic stories are concocted by professionals who don't really believe in their own stories but are simply trying lure naive investors and profit from them.

2009 Sep 13 09:58 AM

[Terence Chan:]

Thanks for taking the time to write your comment Nick. I understand your point. The present does look grim... to quote you "When the stock market rally is based on optimistic stories about a bright future rather than on present reality. Then participating in this rally is no better than gambling. And perhaps its even worse than gambling. " Well one could argue that the stock market always looks to the future and the future carries with it a certain degree of risk. I think you make the most money in stocks if you stick your neck out and not play it too safe. Remember when everything is dandy and its a bull market, the average yearly return in stock is about 10%-15%. But coming off the troughs the returns are 40%-50% or even higher! I think I'd take the 40% over the 10%. We might be coming from different stand points though, since my primary strategy is swing trading, and I don't do buy and hold.


On Sep 13 09:58 AM Nick36 wrote:

> When the rally isn't based on fundamentals. Then for prudent investors
> it's better to miss it than to participate in it.
>
> Warren Buffett sat out the tech rally in the late 1990s. And although
> many people scoffed at him at the time. He was proven right when
> Nasdaq eventually plunged some 88% from its top.
>
> It's no use to feel rich on your paper wealth for a couple of years
> and then find yourself in the poor house eventually.
>
> The reported P/E of S&P 500 is now 129.19.
> www2.standardandpoors....
>
>
> And at this P/E, any stock market rally is purely a speculative rally
> that predicts a very bright future that's unlikely to come about.
> Earnings can improve but not 800% within a space of a few months.
> And only this kind of improvement in earnings will bring the reported
> P/E of S&P 500 down to a historically reasonable value of 16
> at present stock prices.
>
> It's true that there is no limit to how high stock prices can go.
> During the dot com mania many internet companies that never made
> any profits ended up being valued millions and even billions of dollars.
>
>
> But these stock prices are an illusion of wealth and not real wealth.
> It all depends on false perception and some deception by professional
> Wall Street hacksters. And as soon as their latest Pyramid Scheme
> is discovered. This illusion of stock market wealth quickly disappears
> into thin air.
>
> When the stock market rally is based on optimistic stories about
> a bright future rather than on present reality. Then participating
> in this rally is no better than gambling. And perhaps its even worse
> than gambling. Because a lot of these optimistic stories are concocted
> by professionals who don't really believe in their own stories but
> are simply trying lure naive investors and profit from them.

2009 Sep 13 11:11 AM

[adan:]

regarding "...one could argue that the stock market always looks to the future...." -

this seems to only be true when the market is trending, and not good for seeing when a turn is coming -

this might be part of why downturns in the market are so often hard, quick, or crash-like: the market is then in a rush to catch up to what it didn't see (look to) in the future...

either way, best of luck to all of us ;-)


On Sep 13 11:11 AM Terence Chan wrote:

> Thanks for taking the time to write your comment Nick. I understand
> your point. The present does look grim... to quote you "When the
> stock market rally is based on optimistic stories about a bright
> future rather than on present reality. Then participating in this
> rally is no better than gambling. And perhaps its even worse than
> gambling. " Well one could argue that the stock market always looks
> to the future and the future carries with it a certain degree of
> risk. I think you make the most money in stocks if you stick your
> neck out and not play it too safe. Remember when everything is dandy
> and its a bull market, the average yearly return in stock is about
> 10%-15%. But coming off the troughs the returns are 40%-50% or even
> higher! I think I'd take the 40% over the 10%. We might be coming
> from different stand points though, since my primary strategy is
> swing trading, and I don't do buy and hold.

2009 Sep 13 12:55 PM

[David Van K...:]

I beg to differ. Everybody who writes about "things ending badly" is correct in a broad sense, but it doesn't have to be that way for you as an individual investor. Nobody ever talks about having an exit strategy, when in fact every serious investor should always have an exit strategy that preserves gains.

This rally IS based on present realities: (1) We're in a recession; (2) markets tend to rally in anticipation of the end of recessions...8 of the last 9, 9 of the last 10 if you count this one have done exactly that; and (3) there have been signs that the recession was winding down for months now. Hence, the rally. It's not gambling (any more than any investing is gambling). It's making a reasonable decision to invest, based on historically based logic, and protecting yourself on the downside in case you are wrong.

The current 129 PE of the S&P 500 is an anomaly, based on Q4 2008's cascade of bank write-downs that drove S&P's total earnings for that quarter negative. And it's a backward-looking number. Investing is (or should be) forward-looking.

The stock prices are real wealth for those with an exit strategy. You cannot declare that when the market plunged, wealth was "lost" based on stock prices being way down, and then refuse to use the same logic and instead declare that wealth is now an "illusion" when stock prices have gone up. You must use the same logic both ways, not pick and choose.

2009 Sep 13 01:07 PM

[samretlew:]

Hi David,
You've got it right. Why can't others comprehen what you and a handful of others, including the author of the article, are saying. Investing without an exit strategy is like jumping out of a plane without a parachute. I am just reading Jesse Livermore's biography--Remeniscences of a Stock Operator--and am surprised that the world hasn't changed much in 80 years. The people that can spot a trend, trade it to their advantage (long or short), sit tight while it runs its course, and get out when their exit strategy tells them to do so will make a lot of money. To exactly hit the bottom or the top of a trend is not possible, but to ride the trend for about 75 % up (or down in a short position) is possible. Personally, I have no favorite stocks and give a hoot about fundamentals. I simply follow the trend. Yes, I do have small losses, but they are negligible and part of the game; however, when payday comes, the big bounce makes up for all these small losses. I lost less than 10 % in the latest crash and am up about 35 % in total. The proof is in the pudding. Buy and hold (hope) is a gample I am not willing to take because bear markets are fast and viscious destroyers of wealth. Why participate in them when they can be avoided?

2009 Sep 13 03:13 PM

[TLassen:]

Nick36,
Investors always have to remember the P/E value is a trailing indicator. The P/E of 129 shows the CURRENT s&p value divided by the PREVIOUS 4 quarters earnings, thus is a lagging indicator of past market value.

As you know, the market moves in advance of the economic cycle, therefore using a fixed multiplier (such as 'the rule of 20') is advisable to establish an estimated current or future fair value.

You would be better off multiplying the analysts estimated future earnings of the s&p 500 by this fixed multiplier than using past P/E's

So your statement below is wrong. You will see by 1st Qtr 2010 when 4th qtr 2008 results are no longer included, that the P/E will revert to it's "historically reasonable value of 16"

Earnings do not need to improve 800% at all.


And at this P/E, any stock market rally is purely a speculative rally
> that predicts a very bright future that's unlikely to come about.
> Earnings can improve but not 800% within a space of a few months.
> And only this kind of improvement in earnings will bring the reported
> P/E of S&P 500 down to a historically reasonable value of 16
> at present stock prices.

2009 Sep 13 05:11 PM

[Terence Chan:]

David and Sam,
I agree wholeheartedly. Thats why I always tell people you have to have your target prices to exit when you're ahead, or your stop losses to exit when you're wrong. Haven't written had time to write about selling when you're ahead, but I have a pretty detailed article about how to set your stop losses:www.cheapeststocktradi...

2009 Sep 13 08:37 PM