Babies, Bathwater, and Trends

By now you have likely read your September statements, and have internalized most of the bad news. I say “most” of the bad news because, so far, October has not started off as the type of month of opportunity that typically follows an untypical month such as was September.

As I sit here watching the screen, the TSX is down 600 points…no, wait, make that 650….no, now 800…what? back to only down 500?…well, you get the idea.

If one were try to make sense of it all one would have to begin with an understanding of what type of sense one can expect of the market during more normal periods, whatever THEY are.

We all understand that equity markets, to use the most prominent example, are driven by the emotions of greed and fear. Fear taken to an extreme is called “panic.” Greed taken to an extreme is so rare an occurrence that we never really had a term for it before Mr. Greenspan came along and favored us with “irrational exuberance.”

I doubt that the latter term is on too many investors’ minds these days, but it does help to explain why markets tend to rise at a much slower pace than they drop. When stocks are on the rise, the typical investor may not be in such a hurry since the only potential loss is one opportunity, and that is easily replaced. Alternatively, the investor may already be invested and is now looking to enhance returns by scoping out the next market leaders. So there is usually ample time for research, the weighing of alternatives, and the implement of investment strategy.

When markets are in a free fall, as is the case now, investors are suddenly—and I do mean suddenly—faced with real losses. In a panic scenario there is no time for any of the processes referred to above. There is no time, in fact, for any thinking at all, just for potential-loss-induced reflex of selling.

By necessity, this means that things get sold where calm, rational reasoning would dictate otherwise. This is generally good news for those who able to pick up assets at fire sale prices, whether it be strong companies buying up the assets of the weak, companies buying up their own stock, or portfolio managers buying discounted stocks.

On the last point I should mention that I myself consider myself to be a quantitative portfolio manager, having cut my teeth at fundamentalist firm ABC Funds, and having since added many technically-based weapons to my arsenal. During my last year at ABC, we earned a rate of return of over 120% in our more aggressive of the two funds. Even then we understood that general market conditions played an essential role in the future returns of stocks and portfolios. If there were no individual bargains, then the market was no bargain either.

But as many value managers have discovered to their dismay, cheap stocks can get cheaper, often much cheaper. That’s why I’ve devoted much of my time in the last several years learning to identify the trend of the market. Once that is done, we can expect continuance of the trend rather than a reversal. That reversal will eventually come, of course, at which time there will be plenty of bargains with which to fill our hats.

For the record, we identified the downtrend sometime around last June, and have been pretty much in cash every since. We had no idea that the crisis in the market would have been so dire, and who knows if it’s over yet? Trends don’t offer a timeline for their own end, just a means of letting us know when it’s occurred.

Sheldon Liberman,
Portfolio Manager.