Market Lessons: Buy Low, SELL High

Is this a Bear Market rally or a new Bull Market?

After this recent 78% move up in the NASDAQ from the March lows, and a 45% rally in the DJIA, this is the question that is on every investor’s mind.

To answer the question, we must look back in history to crashes comparable to the one we just experienced from the October 2007 highs to the March 2009 lows, a fall of over 50% on the DJIA, NASDAQ and the SP500. Similar periods would be the famous 1929 crash, and the crashes of 1973-74 and 1987.

The Good

In our Clint Eastwood analogy of “The Good, The Bad, and The Ugly”, there are no “good” crashes, only “good” bull markets that eventually follow. On that hopeful note, let’s move on to the bad and ugly.

The Bad

The 1987 crash with its comparatively modest 36% decline, while not good, was the least bad or ugly of those to consider. It was of such short duration and recovered so quickly, that this severe correction is not nearly as good a “comp” to our present market as “the bad” and “the ugly” crashes of 1929, 2000 and 1974.

When we look at today’s powerful 78% rally in the NASDAQ, the DJIA of 1974-75 comes to mind. After the DJIA crashed 44.5% between 1/11/73 and 10/4/74, it rallied a comparable 73.5%.

It would make sense that our current rally in the NASDAQ would be greater than the 1975 DJIA rally, because the current NASDAQ had a much worse collapse of 55.5%. In the past, the DJIA was the proxy for “the marketplace”. Many believe that today’s NASDAQ has assumed that role, and that it is the more accurate representation of today’s overall economy.

If that is so, when the NASDAQ finally ends its current powerful rally, we may very well see a series of corrections and rallies such as those that took place in the DJIA between 1975 and 1982, when a new secular bull market was born.

Indeed, a strong case can be made that the true high of our markets was put in with NASDAQ 2000 bubble high, and the first of the crash and rally intervals took place beginning with the crash of 2000-02. The roller coaster sequence of 2000-02 crash, 2002-07 rally, 2007-09 crash, and the current rally of 2009, may indeed be the proof that we are in such a period. Six more years of crashes and rallies does not bode well for those investors still faithful to the philosophy of “buy and hold”.

The Ugly

When we compare the chart of our current market to that of the 1929 crash, you will see that they are strikingly similar. The 1929 rapid 48% collapse of the DJIA in 1929, although much briefer in duration, produced a similar price pattern to that of the slow motion 49% crash of 2008. Our recent 6-month rally of 45% in the DJIA has been virtually identical to the 5 month, 47% rally which followed the 1929 crash.

What happened after the 1929 rally was simply horrific. The DJIA quickly tanked 26%, and by July of 1932, ultimately collapses by a total of 86%. If our current market continues to follow the 1929-32 pattern, the DJIA should move quickly back to 7000 and finally to a low of 1350 in early 2012. Should this scenario play out, “buy and hold” investors will simply be destroyed. Following the Great Depression, the DJIA did not return to its 1929 highs until 1954. Using history as a guide, today’s “buy and hold” investors who bought in 2007, can look forward to breaking even some time in 2032.

The outlook based on history

Ironically, today’s DJIA seems to be repeating the DJIA 1929-1932 collapse, as the NASDAQ appears to be repeating the movement of the DJIA 1973-82 rollercoaster period. The conclusion to be drawn here is that we are in a bear market similar to both 1930’s and 1970’s; one that will be both “bad” and “ugly”.

We encourage “buy and hold” investors to take full advantage of this bear market rally to protect the gains that have been achieved since the lows of March. We believe that this current rally should be considered a “gift from heaven”, and be sold. Imagine how investors in 1932 must have felt, having held their stock all the way down, they must certainly have looked back at the 1929-30 rally as a great opportunity lost.

Simply stated, for at least several years, it is time to move away from buy and hold investing by buying low and SELLING high. Whether you are a trader or an investor, in light of the magnitude of this current rally, you need to be prepared for a potential downside reversal as we enter the September/October timeframe, historically the worst for the markets.

The bottom line is this… the easy money has been made in this rally. It is now time to “sell high” when this current rally begins to roll over into the next drop.

Remember…Price is Truth!

Comments

[QuasiYoda:]

Yes, Nice Article.

For those who don't believe and aren't incline to take profits you might consider buying a few ETF's perhaps with a 200% gearing to the Bear side. I would stay away from 300% ETF's they seem to dissolve in price whether they are bull or bear.

At this time whose counsel should you follow Greed or Fear?

If you follow Fear you could sell, begin to take cash off the table then if market skyrockets you'll lose out on additional profits but if the market tanks you will have cash available to see you thru the tough times. Also you will have cash to buy stocks at Multi-Decade Lows just in time for the Hyperinflation that is likely to follow after years of Central banks printing money to avoid deflation (won't work imho but that another topic) Stocks like Fertilizer, Silver, Gold, Land, Shippers, etc.

If you follow Greed you keep yourself fully invested if the market rises you keep banking additional Profits reaching new highs in your account balance or rising faster toward your old highs as the case may be. But if the market starts another leg down, technically something that is quite likely, you stand to lose all the radical gains from the last 6 months. You may think Oh I'll sell but it is easier to consistently take profits in a market sell off if you already have done so that cash in your account bears witness to smart protection of hard won assets.

My Advice do your own Risk Reward Scenario on your particular portfolio. Push the risk and reward to extremes to see the full picture and then protect yourself accordingly.

Sep 14 06:12 AM

[Macro_Man:]

If we look at the macro economic picture, nominal global GDP is under terrific pressure and will not be growing as it has done in the past.

The correlation between nominal GDP and corporate profits is extremely high. This implies lower earnings and a lower P/E...just check Japan and Nikkei since their bubble burst.

Though the Fed and other central bankers are doing their best, it is not easy to prevent deflation in a credit oriented world as they control only the monetary base...not the multiplier or the velocity.

Sooner or later, we will see the dollar strengthening and it will soon be mighty USD uber alles (except for the Yen).

I am long USD (against puts), long UST. If gold and silver show that they have topped out, will short them. But early for that

Sep 14 07:52 AM

[Wayne A. Co...:]

Great points Graham. Buy and holders, and the perpetual long only value managers who are crowing about their returns will feel real pain if they don't wake up and change their ways soon. These are the same people who took an absolute beating in 2008 but they have forgotten the carnage already. At the very least they should lower their exposure.

This rally has fostered such complacency that the next round of wealth destruction will not only be damaging monetarily, but even more so psychologically.

Sep 14 08:01 AM

[Tony Petroski:]

I enjoyed this article. The author:

"Remember…Price is Truth!"

Truer words never written.

To the commenter Quasiyoda: Keep capitalizing "Profit." You have to love that.

Sep 14 09:32 AM

[Bill L.:]

Nice article.
Buy low, sell high... Almost all the greats have said this at one point or another, and it's interesting that such a simple concept is so paramount in all the best pros. Why? Take the current market; we do appear to be repeating the 1929-1933 type move. Owners of stock have now be privileged to partake in one of the most historic 5 month moves ever; a very good exit point. Instead most will not sell here, but hold out for continued highs. But the truth is Dow 14,000 was achieved with considerable leverage in ALL parts of the economy as well as the financial markets. Sideways for 10 years is what's likely (look up where we are in the 17 year cycle). I'm not being pessimistic but simply a realist. You can only take what the stock market gives you.

Sep 14 10:19 AM

[zorro6204:]

Oh for heaven's sake, just because a chart happens to somewhat match a 1930's chart doesn't mean the same thing is going to happen in the next frame. To act based on that alone would be madness.

Personally I think the chances of a double dip are pretty high, based on the levels of personal debt and upcoming problems with bank assets, but at least I have reasons for this thesis, not moldy lines on paper. Absurd.

Sep 14 11:07 AM

[Bill L.:]

I believe it is reasonable to infer that under similar circumstances people would act similarly. There are many other situational similarities to that period, and based off that we can observe how market participants acted in those periods. You shouldn't turn a blind eye towards the study of history.


On Sep 14 11:07 AM zorro6204 wrote:

> Oh for heaven's sake, just because a chart happens to somewhat match
> a 1930's chart doesn't mean the same thing is going to happen in
> the next frame. To act based on that alone would be madness. <br/>
>
> Personally I think the chances of a double dip are pretty high, based
> on the levels of personal debt and upcoming problems with bank assets,
> but at least I have reasons for this thesis, not moldy lines on paper.
> Absurd.

Sep 14 11:21 AM

[Mad Hedge F...:]

ddad The dinosaurs of the market, like myself, are collectively being struck by the similarity of the current stock market and that of September 1987, just before the one day, 25% plunge in the Dow. That was when I tied to buy stock with the index down 300 from a payphone in Paris, only to have the trader at Morgan Stanley burst into tears and smash the phone down on the desk (remember that David G.?). My new guru is Gluskin Sheff’s strategist David Rosenberg, who says that stocks have already discounted two years of recovery and now carry a lot of risk. It is priced for 40% EPS growth and a “V” shaped recovery, which we have zero chance of getting. GDP this year will come in at negative 2.5%, and will claw back a listless 1-2% rate in 2010. Stocks are discounting a 4% GDP growth, compared to only 2% for bonds, so he’d much rather own those. With a deflation rate of minus 2% and high yield returns of 12%, junk now offers a 14% inflation adjusted yield, not bad. The secular 25 year bull market in credit expansion is over. Rent still accounts for a third of the CPI, and they are falling for the first time in 17 years. Sure, we’ll see ephemeral sugar highs like those for cash-for-clunkers and the tax credit for first time home buyers. But at best, it will only add up to a series of small “W”’s, or what I refer to the as the “square root” shaped recovery. With the price of everything stretched, you better start reeling in some of that risk.

Sep 14 11:26 AM

[johnm:]

The 1968 - 1982 secular bear market looks similar to the
1929 - 1942 and 2000 - ???? bear markets if the proper unit of
accounting is used. Paper money wont do it because the Fed keeps debasing the dollar. But if you use a universal unit of value like ounces of gold and express the Dow (S&P) in ounces of gold, the path of the market is very similar in these three secular bear markets.

Sep 14 04:36 PM

[Value Added:]

The psychology behind current market behavior is the same as the 1930s. The specific weaknesses in the system this time around are not identical, but similar in kind. If there is a single major difference between the rebound following the '29 crash and this moment we find ourselves in, it is this: our newer economic theories, heavier government control, better mathematical models, and advanced computer wizardry have deluded policymakers and investment bankers into thinking the games of manipulation can continue with impunity. Expect equities to get hammered.

Sep 14 08:29 PM

[Value Added:]

Interesting... moments after posting above, I came across the following BBC article:
news.bbc.co.uk/2/hi/bu...
Underscoring what I had written.

Sep 14 08:33 PM

[KIT:]

They cant control the bond markets reaction to manipulated rates. Its ten times the size of the stock market and has a mind of its own.

On Sep 14 08:29 PM Value Added wrote:

> The psychology behind current market behavior is the same as the
> 1930s. The specific weaknesses in the system this time around are
> not identical, but similar in kind. If there is a single major difference
> between the rebound following the '29 crash and this moment we find
> ourselves in, it is this: our newer economic theories, heavier government
> control, better mathematical models, and advanced computer wizardry
> have deluded policymakers and investment bankers into thinking the
> games of manipulation can continue with impunity. Expect equities
> to get hammered.

Sep 14 10:27 PM

[Dan in mpls:]

Well, I'm smarter than the next guy so I'm gonna stick with my stocks until the last moment! The day it starts to go down, Im gonna (if I'm not busy doing something else that day and not by a phone) sell everything and join the - what, it 50 percent- of the stock owners who have owned their shares for less than a year and sell. Yup. Its the buy and hold idiots who will lose the money.
This market has to be like 1929 because we are all racing to be the greater fool. We cannot believe the party that has lasted our lifetimes has ended. And we have the full power of the Federal Treasury in full and wholehearted agreement with the American people.
This rally has factored in nothing but the united desire of millions of people across the nation to make a quick buck. I could care less if Wells Fargo ever makes a dime. I bought on the years low and I want just a little more money!

Sep 15 09:59 AM