Seeing the Other Side of the Decline

Reader Steve Albertson writes...

"Seemingly obvious question, but are you as bullish as you were a week ago before this huge drop, and a second question, could you share what you see in the pattern of Google (GOOG) that is so bullish to you? I see in the last year a lower high and a lower low for the first time ever. I noticed that Allan Harris has been calling for a major drop at the same time you seem so bullish. Since you are asking for questions, do you have any updated thoughts on Apple (AAPL) and (QCOM)?"

'Interesting' questions, Steve.

Technical analysts attempt to measure how strong, high, and enduring a price move will be, and invest accordingly. The trick is to analyze the markets in a time frame appropriate to your (each investor's) tolerance for risk and objectives. Different time frames allow for differing perspectives. A plummet to many investors is a mere speed bump to others. Investors require a certain confidence, even faith, to see the other side of the decline, the consequent rise.

For 10 years now, you have requested my opinion re Wal-Mart (WMT). As a former employee, I understand that the sudden plummet in late-1999 to ~$40 from its all time high of $70 occurred seemingly unexpectedly, and with ferocity. And then came the next nine (9) years of range trading -- $64 to $42 and back again, with the past ~3 years hovering in the low $40s. You could not understand then how I could foresee better days while the stock plummeted, nor could you accept that reality while the shares wandered about Wall Street's desert, seemingly aimlessly. But that wandering never was aimless; not then, and not now.

The same holds true for today's market, despite (in spite?) of its fearsome look and set of jaw. Remember that I fretted, feared, and warned for years about the very events that transpire today. My colorful (and beloved) metaphors pointed the way: the US would be the "epicenter" of the coming decline, one that finds us standing, one foot dangling, at "Mather Point." It tickles me that, years on, The ECONOMIST chose to visualize my metaphor with the cover art for the current issue.

I have believed for some time that all is not right with the global financial system. The fact that the markets decline today as they catch up with my fears from yesterday does not gratify me; I would prefer to be wrong. Yes, current market circumstances prove enervating; in fact, global markets decline hard as I write this post late-Sunday night -- pointing the way to yet another ugly opening 'rotation' (to borrow a term from the options markets). But in these difficult days, remember the many investing axioms I have shared, and especially this one: Seek the inflection point, the moment of extreme, obscene weakness. In a (seemingly) perduring (thanks to entropy, nothing truly perdures) down trend, part of that moment will occur as a large gap down at the opening.

While this decline is dissimilar from declines previous in its extraordinary set of circumstances, it also is similar to all other declines predicated on a set of facts that become increasingly familiar:
• The Mexican debt crisis of 1982, where that country's starvation for liquidity and solvency caused us to pump money, and more money, into the financial system. And thus ended with an explosive bang the 16 year high level consolidation described previously;
• The SE Asian currency crisis of 1997, when we thought the meltdown of the Thai baht, Malaysian ringgit, et al would infect the rest of the world, and
• The meltdown of Long Term Capital and Russia's debt default of 1998, when chaos rocked the global markets.
• And other declines, based on similar circumstances and equally horrific.

Check the charts for those epochs; perhaps of note is that the worst pain adminstered to the greatest number of people occurred during the summer and early autumn months. (June through September.) Each decline prompted fear that the end days were upon us. Guess what? The markets recovered from each of them. And here we sit to discuss the (de-)merits of this decline. Which all adds (but does not sum), as to why the markets do not frighten me, now or ever.

Dorsey Wright:
"The market will not bail you out of mistakes and we would rather lose opportunity than lose money. Of course during these times, magazines and media try to make it look ten times worse, which doesn't help customers' psyche. During the bottoming process, we always find that new sectors emerge and provide leadership. There is always opportunity. We look for those opportunities to emerge among the rubble by looking for higher bottoms compared to the market. While it seems that everything has been going down over the last couple months, the reality is it hasn't been. Good things occur even, if you look under the surface. Despite another week of extreme volatility and a move to new lows by the broad market averages, there are some positive things occurring underneath the surface. More specifically, as the image below shows, we have seen relative strength emerge in some of the Sub-sectors and Mini-sectors. For example, on the Sub-sector level, we have recently seen the Diversified Financials reverse on their RS chart vs. the market, as has Household Goods. If you drill down a little deeper, to the Mini-sector level, you can see for example that Food Products has shown a similar positive upside reversal on its RS chart vs. the market. This is good information to have as you develop your Shopping Lists of ideas for when we move back to an offensive posture." (My apologies to All, Dorsey Wright Analytics included, for the lengthy quotation; it includes much fodder for deep and lengthy thought.)

An illuminating moment, for me, occurred during Thursday's debate. Biden and Palin bloviated about this and that, and ignored blithely the chaos in the financial markets. And then it struck me: each candidate assumes this moment in (financial) history shall pass; heck, they have heretofore. (I recognize the candidates prefer to ignore the chaos for political reasons, as well.)

Markets come and go, prices rise and fall (and sometimes trend), but through thick and thin, value always is there; often elusive and sometimes illusive, but prices are both always. Value always wins out. Imagine, if you can, an ideal world, one in which business and continuing enterprise value predicate stock prices rather than the less meaningful (meaningless) price per share, and you will have a sense of what Oscar Wilde bemoaned so many years ago.

I invest long term, in companies that have continuing enterprise value, and excellent executives; moreover, I prefer and attempt to purchase these companies during intermediate term declines within a continuing long term uptrend, at or near price support, and retain some cash for times such as today. Finally, I do not worry overly much about long term investments whose share price declines only in sympathy with the market rather than from the pillaging of their business from lazy or crooked executives, disciplined competitors, or a diminishing opportunity in its chosen field of endeavour.

I acknowledge that perspective, experience, and the ability to discern what could occur next -- and a large helping of confidence! -- helps long term investors weather the frequent storms. But from such storms, such declines as occur today are born the phenomenal buying opportunities of tomorrow. A tomorrow that will come, as certainly as the sun rises in the east and night follows day.

Comments

[curious cat:]

the end is near!

2008 Oct 06 09:40 AM

[Shiv Kapoor:]

I agree; this is a time when perceived risks are high while the real risks are low because of where long term valuations are.

If long term investors follow an asset class allocation of say 60-30-10 (Equity/Bonds/Cash); stick to it and the rewards should follow. If your portfolio has shifted you to a 52-35-12 situation because of the fall in equity; rebalance. In normal times rebalancing once a quarter is more than adequate; in times of volatility it is better to rebalance the earlier of once every quarter & a date when there has been a decline of 8% from the date of the previous rebalance date.

On valuation, the market is trading at a discount to its long term multiple; in the circumstances a long term investor might want to consider shifting allocation to say 70-20-10 => aim being to return to 60-30-10 when market is back to trading at its long term multiple whenever that might occur.

Also folks need to watch their sector allocations since the declines in value have not been kind to several sectors.

Finally - within sector allocations - make sure stock risk is diversified (particularly in financial services) - using an ETF diversifies risk well but you give up the opportunity for alpha gains associated with good stock selection - I would say in this market diversification is a must and being stock specific in your selection is better than blind diversification.

2008 Oct 06 09:57 AM

[bbowen7:]

It is always darkest just before it goes completely black.

2008 Oct 06 11:50 AM