Thursday, May 27, 2010
Wednesday, May 26, 2010
Four Major Lines of Metrics
Ritholtz: There are four major lines of metrics that we’ll look at when we’re talking about the overall market. We’ll look at valuation, which is as much art as science because a lot of valuation is based on future earnings expectations. As an aside, this is why the so-called Fed model is worthless – its so idiotic – because you can’t say, “Based on these forward estimates, here’s what’s the value of the stock is.” Well, what if the estimates are wrong? And those estimates have been wildly wrong for the past year! So true valuation – not Wall Street’s worst guesses – is one thing we look at.
We look at sentiment measures, which for the most part, are most significant when they hit extremes. Sometimes they hit dramatic extremes and then they’re very, very significant – like we have seen recently.
Third, we look at technical measures – overbought and oversold, trend, institutional ownership, short interest – which is a combination of factors. I know that the fundamentalists’ their eyes glaze over when I discuss trend and relative action to trailing moving averages and a whole bunch of other things. But its objective data, not subjective, and therefore is more reliable to us.
Finally, everything is relative to monetary policy and interest rates. If the Fed is tight and rates are high, valuation almost doesn’t matter as much because there’s only going to be so much going on from the macro economic perspective.
10 Investing Rules - Flexibility
• Whether a premise is fundamentally true or false is irrelevant as to whether it is actionable. If enough fools believe something is so, it will impact the markets.
• Always be conscious of the cognizant biases and selective perceptions you bring to investing. Learn to recognize the same bias in the crowd, the media, and Wall Street. Avoid the herding effect.
• After a collapse (i.e., a 55% market sell off), most of the terrible structural news that existed before the collapse is reflected in prices. Let it go.
• You must acknowledge when the data gets stronger or weaker, regardless of your current market posture. Be skeptical, but not rigid.
• Market Pros simply cannot afford to sit out a major (i.e., 75%+) rally; Individuals that miss that sort of move should reconsider what their investment strategies are. If your approach has you long during selloffs and in cash during rallies, something is wrong.
• Everything cycles: Recessions turn into recoveries; bull markets give rise to bear markets. Every rally that there ever was or there ever will be eventually ends. Adapt to this truism or lose your money.
• One of the hardest things to do in investing is to reverse your thinking. It is even more difficult to do after a specific approach has been profitable for a long time. The longer the period of successful thinking, the more important the reversal will be.
• Cheap markets can get cheaper; Expensive markets can get dearer.
• The markets frequently diverge from the macro economic environment. This can be both long lasting and maddening; Your job is to be aware of how wide the gap between the two is.
• Variant perception is a rarity; Identifying the moment when the crowd figures out they are wrong is rarer still.
from Barry Ritholtz
Bob Farrell's 10 Market Rules
Bob Farrell was a legend at Merrill Lynch & Co. for several decades. Farrell had a front-row seat to the go-go markets of the late 1960s, mid-1980s and late 1990s, the brutal bear market of 1973-74, and October 1987's crash.
He retired as chief stock market analyst at the end of 1992, but continued to occasionally publish. Rumor has it for a humongous donation to Farrell's favorite charity, you can get on his very exclusive email list.
Marketwatch gathered some of Farrell's more famous observations, and republished them as "10 Market Rules to Remember."
1. Markets tend to return to the mean over time
When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people's heads. It's easy to get caught up in the heat of the moment and lose perspective.
2. Excesses in one direction will lead to an opposite excess in the other direction
Think of the market baseline as attached to a rubber string. Any action to far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.
3. There are no new eras -- excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots. Look at how far the emerging markets and BRIC nations ran over the past 6 years, only to get cut in half.
As the fever builds, a chorus of "this time it's different" will be heard, even if those exact words are never used. And of course, it -- Human Nature -- never is different.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
Regardless of how hot a sector is, don't expect a plateau to work off the excesses. Profits are locked in by selling, and that invariably leads to a significant correction -- eventually. comes.
5. The public buys the most at the top and the least at the bottom
That's why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing.
Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.
6. Fear and greed are stronger than long-term resolve
Investors can be their own worst enemy, particularly when emotions take hold. Gains "make us exuberant; they enhance well-being and promote optimism," says Santa Clara University finance professor Meir Statman. His studies of investor behavior show that "Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks."
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
Hence, why breadth and volume are so important. Think of it as strength in numbers. Broad momentum is hard to stop, Farrell observes. Watch for when momentum channels into a small number of stocks ("Nifty 50" stocks).
8. Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend
I would suggest that as of August 2008, we are on our third reflexive rebound -- the Januuary rate cuts, the Bear Stearns low in March, and now the Fannie/Freddie rescue lows of July.
Even with these sporadic rallies end, we have yet to see the long drawn out fundamental portion of the Bear Market.
9. When all the experts and forecasts agree -- something else is going to happen
As Stovall, the S&P investment strategist, puts it: "If everybody's optimistic, who is left to buy? If everybody's pessimistic, who's left to sell?"
Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.10. Bull markets are more fun than bear markets
Especially if you are long only or mandated to be full invested. Those with more flexible charters might squeek out a smile or two here and there.
Typical Secular Bear Market and its Aftermath
Courtesy of the Strategy desk of Morgan Stanley Europe. It shows what the average of the past 19 major Bear markets globally have looked like:
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Typical Secular Bear Market and Its Aftermath
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