The Rally is Coming: Always Buy Too Soon

Always buy too soon--- because no one will tell you either when the rally will start or, more importantly, how long it will last. Of course those are the two things you want to know, but all you really have to go on is the experience of the past. This is not going to be a technical analysis of a series of numbers or chart formations that have predictive capabilities. Instead, it is intended to be a mild sedative to calm your collective fears and to allow for a relaxed analysis of the corrections of the past. You have to prepare yourself for the rally that is surely coming, and it may just arrive sooner than you think--- today, even.

Yesterday's classic e-mail question wondered: "Is this ever going to end?" The reference was to the eleven-month correction playing out concurrently in both the investment grade value stock [IGVS] and the income securities markets--- the anxiety was cloaking the monitor screen in doom and gloom. Most of you would be surprised at how frequently the current scenario has repeated itself during the last 80 years. Quite typically, a new set of abuses has been identified as the cause of the problem, and it is likely that a new set of regulations will be enacted for monitoring by new legions of enforcers.

There is more in those six little words (Is this ever going to end?) than meets the eye, and too many investors share the misconceptions that lie beneath the surface: The market has never and will never be a one way ticket to ride (smile Beatles fans). None of the important aspects of the voyage (advances, declines, speed, beginning, or end) are predictable, by anyone, no matter how overpaid or well credentialed. It has become clear to me over thirty-five plus years muddling through the investment exercise, that most of the mistakes are made by people who over complicate the process. This is not at all rocket science. In fact, the only science(s) that are at all helpful are economics and management--- mostly management, since the market and economic cycle realities are fairly clear.

Good investment portfolio management, for example, would have you looking for quality additions to your portfolio inventory for later sale at a reasonable profit. Management includes the discipline, rules and procedures that are necessary to create, implement, and control an investment plan. It requires an understanding of what is going on, in and around the portfolio, so that you can react rationally rather than emotionally. If you have been taking losses over the past several months in investment grade securities, and/or if you have been buying the currently more popular, but historically more speculative, fear products of the moment, you are on the wrong track. The rally is coming on this one!

In the simplest of terms, stock market corrections are caused when there are more sellers in the markets than buyers. Corrections in the income securities markets are normally caused by changes in interest rate movement expectations. The duration of stock market corrections will vary with the nature of the events that cause the correction in the first place. There are six types of selling, but only two types of buying. What? People buy stocks either to hold them for profit taking, donating, or bequeathing in the distant future, or to trade them in a more businesslike manner for profit taking ASAP. Securities are not purchased with the hope (or knowledge) that the market values will diminish--- except in the case of portfolio window dressing, where the institutional money managers really don't care one way or the other.

Selling, on the other hand, is a much more complicated decision, with six separate and distinct motivations and an expectation of financial loss:

1. Loss taking on securities that have fallen in market value because of the irrational fear that they will never be able to recoup the losses quickly enough, if at all. Why speed is important puzzles me, but analysis of a few charts of IGVS would quell such fears. With regard to income securities, this fear of market value erosion is somehow equated with loss of income--- a relationship that just doesn't exist. Fear selling is generally more prevalent in inexperienced investors.
2. Window Dressing is normally a quarter or year-end phenomena where money managers cull unpopular issues from portfolios to appear wiser to their clients. But with most investors addicted to personal on-line portfolio access, many individual managers have succumbed to client pressures and have begun to look a lot like their institutional brethren. Wrap Account managers are likely to use these strategies on a monthly basis as well.
3. Greed driven switching from a weak stock or bond market to a hot new speculation is another form of selling that peaks toward the end of corrections, as investor patience wears thin. These sellers push whatever vehicle has had the best recent performance even higher, helping to create the next bubble.
4. Pure profit taking is my favorite reason for selling, but a surprising number of professional money managers hold on to their winners far too long, and little of this type of selling takes place so deep into a correction.
5. Stop loss profit taking in Mutual Funds and in individual securities produces a significant number of sell transactions, and much of the liquidity produced falls into the managers' wait-and-see, or market-timing, cash allocation.
6. Finally, and most importantly, there is the financial adventure of Short Selling, in which speculators expect to make money from a continued decline in a stock's market value. It is disturbing that the elimination of the up-tick rule has allowed large-scale traders to sell securities they don't even own in large enough quantities to wage war on target companies. This strategy involves selling borrowed securities at the current price and then "covering" the position with stock purchased at a lower price and pocketing the difference.

So, the various categories of sellers, regardless of their motivation, create large pools of money, while the buyers accumulate larger and larger stock holdings. Now the buyers, you'll recall, have no interest in selling their positions at a loss. Sooner or later, some gutsy financial gurus will declare the stock market oversold and full of bargains; some of the brighter ones have already been talking about how cheap municipal bond based securities have become. A few days of positive market numbers will create some itchy-trigger-finger, short covering that will spiral the equity markets into its next feeding frenzy, gobbling up even the memory of this correction.

But the markets cycle onward to newer highs, and to higher lows, with no right or wrong, no good or bad--- just some simple truths, that experienced decision-makers learn and thrive upon. No person ever became richer by selling at a loss during a correction or by waiting for the market to achieve new high ground to get new positions started. Always, yes always, buy too soon during corrections.

Comments

[Robster:]

You only seem to address flimsy buyer motivation with no real reason behind it. With so many cockroaches crawling out under financial rocks and hedge fund blowups becoming more prevalent how can we see this rally, just curious? This is not scaremongering, this is actually happening.

2008 Mar 14 06:10 AM

[Robster:]

You only seem to address flimsy buyer motivation with no real reason behind it. With so many cockroaches crawling out under financial rocks and hedge fund blowups becoming more prevalent how can we see this rally, just curious? This is not scaremongering, this is actually happening.

2008 Mar 14 06:12 AM

[the final h...:]

good advice column for the brain dead. 100 years from now, everything will be fine.

2008 Mar 14 08:48 AM

[cynic69:]

It seems to me that there is a good chance that the world economy may nerver recover from the lack of cheap oil. I think that the world average standard of living is going lower at the same rate that the price of oil is increasing. Its not easy for the human brain to get its arms around the fact that critical changes happen as time marches on. The lack of cheap oil is going to cause dramatic changes in our life style and our markets.

2008 Mar 14 11:06 AM

[CoolcatRepo...:]

I seem to recall similar advice from the Motley Fools in 1999: "Just buy great stocks, because they will always go up." We all know how that turned out.

Kevin Kennedy
Publisher
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Now publisher of 5 great investment newsletters!
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2008 Mar 14 01:24 PM

[locke:]

Gale: For your prediction to be true, technology would have to stop advancing. God luck with that.

2008 Mar 14 04:25 PM

[damienhaas:]

Buying now and the market fall another 5 percent, buy again the market fall again for 5 percent. I am not sure a lot of investor around can take this type of pressure. Why not keep the cash in hand and wait for the bottom. No reason to believe the bottom is anytime soon.

2008 Mar 14 09:52 PM

[vboring:]

it should be remembered that there have been decades when the markets didn't actually always go up.

during the 1970-1980, the Dow Jones returned an astounding 0%. Nominal!

yes, the markets have trended up fairly smoothly since Nixon took us off the gold standard, but to blindly assume that they will just keep going up is just a bad foundation for an analysis.

2008 Mar 15 02:18 AM

[vboring:]

another perspective on my point above is that the Fed and the federal government are doing everything in their power to prop up the market, tripping over each other with idiotic bailout plans, debt and currency be damned.

if the Fed and the federal government are on one team, do you really want to be on the other? they control the printing presses. how can you win against that?

2008 Mar 15 02:25 AM

[sammyg123:]

Yeah. The Fed and the government are just super when it comes to getting the economy right. Their intentions are right, but government isn't the answer on this one. There is a systemic risk issue here that printing money won't solve, and nor will any regulation, unless we can go back in time and make derivatives and subprime mortages illegal.

So, buy the dip, right? Well, how far does this dip go down? I suspect we'll find the bottom sometime after a few more Bear Stearns shoes drop, and yes there will be more. Dogma developed from historical statistics doesn't predict the fallout from the subprime/credit crunch/financial institution failure spiral of doom. We don't know where it stops, and we are not in the last innning.

So, I'm not buying the dips, I am covering my short sales. And, when the economic situation improves, I'll know. It will be after the Fed raises interest rates to control inflation, gets inflation under control, and then starts cutting rates. We are looking at a terrible market for two years, unless you really know how to trade.

It's a trader's market. In these environments, stocks are just not where to be. When in an inflationary market, commodities (hard and soft), oil, and precious metals work. Bond yields are effectively negative, corporate profit margins are under pressure due to inflation - standard investments are not happy places right now.

Read Black Swan, by Nicholas Nassem Talib, and you'll see that what we are in is a real crisis, with a long tail of consequences which are not positive in the short term. Know the risk before you get in. It's tough to know how deep the risk rabbit hole is right now.

Good trading.

2008 Mar 15 10:56 AM

[damienhaas:]

vboring, How about Hyperinflation, Printing money like the way Fed do will come back to haunt the US Economy!

2008 Mar 15 10:12 PM

[whidbey:]

The Pollyanna principle or Pollyannaism describes the tendency for people to agree with positive statements. It is sometimes called "positivity bias." There is also a trait which calls for "resolute action when in doubt". This is tough work in the large stock market under the influence of fear, anger and political goal pursuit. Are you in over your head giving such advice?

2008 Mar 16 03:12 PM