Markets can be a pig!
So the news over the last few days has been awash with “swine flu”. As serious as it may be, the story started hitting the wires towards the end of last week and the media had a field day building it up over the weekend.
So guess what, on Monday morning Hogs open limit down! They did trade off limit briefly during the day, allowing trapped longs to liquidate positions at a horrible price, before closing limit down.
This is a great example of how fickle markets can be. No one wants Hogs all of a sudden. Yet according to the World Health Organisation this current flu virus contains components of flu from humans and birds as well as pigs. Even more incredible is the fact that, to date, not a single pig has died from it! The market is reacting to the name, not the facts. This is because the market is made up of humans and humans are illogical creatures. This demonstrates why investment based upon “valuation models” can be so dangerous.
This is a market we have been watching for the last few weeks, since long before swine flu came into vogue. Here’s why…
This is a market in equilibrium, with price having oscillated around 73 for the last 3 months and passing through that equilibrium price dozens of times.
A market in equilibrium is like a compressed spring, just waiting to be catapulted in one direction under the influence of an impulse, which is the phase in the cycle that follows equilibrium. As we noted last week in the S&P, which also remains in equilibrium so far, there is no way of knowing which way the impulse will be – up or down. Most of the time the reason for the impulse does not become known until weeks after the event, by which time the move is over.
Gapping limit down is the ultimate form of impulse and now we would expect a trend to develop out of this. So the market is telling us to expect lower Hog prices. Sadly the huge gap down took away our opportunity to short this market for now as price is too low to meet our risk/reward requirements. Also as mentioned in last week’s S&P article, when the impulse finally arrives, rarely does the market hang around waiting for you to get a good entry price and you just have to be brave and pull the trigger. In this case, with the gap, even that option was taken away from us.
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Copyright © Simon Townshend 2009, all rights reserved.
Follow Up: A week later we see nice follow through as expected. Its just a shame that the gap stole our choice entry point. But that’s life and there is always another bus coming and its far better to pass on a trade than to compromise your risk/reward rules.
Watch for the impulse
Coming into today the stock indices are in perfect equilibrium. This suggests a decent move is about to start and we will watch for the initial impulse to tell us which direction we are heading in next. I would expect to see this impulse within the next 1-3 days. Today would be nice to finish off a crappy little choppy week with a bit of action and profit.
I never try to guess which way we will go in these situations and am happy to admit that I have a poor record at making such guesses, which is why we only trade once the market has told us which way it is going! You have to be on your toes though because once these moves start they rarely give you much of a chance to hop aboard. The move to electronic trading has eliminated the leisurely entries that we used to get when all the volume flowed through the pit. Now you just have to pull the trigger, place your stop and walk away without trying to finesse the perfect entry!
Academically I note that gold has been rallying for the last week and rallying gold suggests the next move in stocks could be downwards. But it would take much more that this for me to bet that we break south. Maybe gold’s action improves the odds of a move down in stocks from a 50/50 bet to a 60/40 one.
Personally I’ll wait patiently until the market whispers in my ear that it is now going up or down and then we’ll join in for the ride. So fasten your seatbelts folks and lets see what unfolds.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend 2009, all rights reserved
Follow Up: The S&P breaks out to the upside gaining 9% in as many days. This move is even more impressive given that the market is in a downtrend and had already rallied 28% off its low. As we have said many times before bear market rallies can be very dramatic and are usually more impressive than rallies in bull markets, however counterintuitive that might sound.
How long do bear markets last?
Or equally importantly – how long do they take to recover from?
Recently a financial commentator was heard exuberantly announcing that times are tough but don’t worry in a couple of years the market will recover its recent losses. Oh really? That doesn’t sound too plausible, although if last year taught us anything it is that just about anything is possible, however improbable!
Intuitively we know that there is way too much damage done for this market to regain its losses quickly. This is the largest market decline since the 1929 slide and whilst that market did eventually recover to its 1929 highs that took some while as we will see in a moment.
We should also remember that on average markets fall at approximately three times the speed that they climb. There are many credible explanations for this phenomenon and whilst it is a very crude tool to put too much faith in, it does provide a rough benchmark of what is reasonable to expect (once the market finds the bottom of course). If a bear market from peak to trough lasts 2 or even 3 years, then we should be thinking roughly in terms of 6 to 9 years for a complete recovery to the previous highs. This factor of three is a widely known average across all markets and is not specific to the stock market per se.
We looked back at all the major declines in the Dow Jones over the last century to put the current market into some context and here are the results.
The 1929 decline was obviously far worse than the current market with a staggering 89% peak to trough loss. However it is the time that we were particularly interested in for this exercise. A decline taking approximately 3 years took a whopping 26 years to be recovered. The market fell roughly 8 times as fast as it recovered.
The second worse decline was in 1973, although at 47% loss this was less bad than we have seen so far this time! This bear market lasted approximately 2 years and took 10 years to be fully recovered from. So it took 5 times as long going back up as coming down.
The two more recent and less severe declines had recovery periods shorter in duration: 1987 was only a 3 month “hit”, but still took 2 years to recover. So about 8 times as long. Whilst the 2000 decline put in a performance much better than the average, taking only 4 years to recover from a 33 month decline. It is also worth remembering that this was also the least severe fall in percentage terms and logically the size of the loss would also have an effect on the recovery time. Hence the contrast with 1929 at the other end of the spectrum.
Obviously our current bear market hasn’t quite reached 2 years in duration yet, but neither is there any evidence yet of any bottom being found. But even if we were to march straight back up from here, the prospect of regaining those 2007 highs in just a couple of years is about as likely as a win on the lottery! At some point in time we will get there, it just won’t be anything like as quick as most people believe or hope.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend 2009, all rights reserved.
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