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The Speculator
All this hopelessness a good thing for
optimists
If you’re looking for capitulation in a dramatic way, you
won't find it. Instead, you'll find a spreading hopelessness … and a
few optimists primed for the start of a new bull
market.
By Victor
Niederhoffer and Laurel Kenner
The empty houses are filling quickly. There are
new people, most of them young. In a year, maybe two, maybe three,
Mill Valley will seem no different to the eye from any other small
town. In five years, perhaps less, it will be no different. And what
once happened here will have faded into final
unbelievability.
-- Jack Finney, "Invasion of the Body
Snatchers"
Our column last
Thursday -- “Foil the
money-snatchers: Buy a stock” -- received more reader response
than anything we have written. In that piece, we drew upon Jack
Finney’s “Invasion of the Body Snatchers” to capture the manner in
which investors had become engulfed by market bearishness. Inspired
by the book’s characters, who refused to allow themselves to fall
prey to the emotion-draining pods, we suggested to readers that now
was a propitious time to make a bullish market stand.
A
number of readers took heart from this message. We received hundreds
of messages like these: “Thank you for bringing back hope,” and “We
will foil them, and thanks for helping to keep us focused on the
positive.” David Hillman, president of Sequent Technologies of
Cincinnati, was particularly eloquent in voicing the spirit of the
pod-fighters: “The saving grace of all this is that, as always with
hard times, we come out battle-scarred, but far wiser. And it's
wisdom that takes the day. As Nietzsche wrote, ‘That which does not
destroy me makes me stronger.’ We need to believe once again in
ourselves and the market.”
The most common criticism of our
views was that the market would never reach bottom as long as there
are still a few hopeful people out there hanging on to their longs.
One reader wrote in Thursday afternoon to tell us he was sorry we
lost money on the stocks we bought Monday, and to “stop telling
people to buy -- they are getting killed.” Some criticized us for
basing our optimism on a sci-fi movie plot. “It makes me wonder what
other far-out (borderline psychedelic) sources you’re getting your
market insight from,” wrote Bill Scar of Chicago. “Dissolved
credibility is always but one ‘pod’ away.”
The polar
reactions of the market optimists and pessimists reinforce the
message of our column: Bullishness and bearishness are more than
mere opinions about market direction. They represent fundamentally
differing stances vis-a-vis risk and opportunity that may
well shape the returns of your portfolio over the coming weeks and
months. Let us show you why.
Capitulation vs. the loss of hope
A
fundamental thesis of the market pessimists who wrote to us is that
we need a washout -- a vicious decline on extraordinary volume -- to
blast the weak longs and lay the groundwork for a new bull market.
To be sure, there have been occasions in which this scenario played
out, most notably in October 1987. Such capitulation represents
market anxiety: it is a panic reaction in which the bulk of
individual investors are seized by the impulse to just sell
everything at once.
A capitulation of equal import, though
not of such dramatic character, can be found in investor depression.
Instead of throwing stocks away out of anxiety, investors lose hope
in the market. They become convinced that any investments they make
are bound to lose. Volume decreases and sentiment becomes
extraordinarily negative. It was precisely this scenario that
preceded the great bull market in August 1982.
We suggest
that this latter situation, rather than anxious capitulation, has
seized the market. Indeed, many people wrote in to explain why they
had lost hope. We received this heart-wrenching report from a couple
in Minnesota: “Our advisors, in February of 2000, advised us to stay
invested. We have lost 40% of our retirement portfolio as a result
and will not recover in this lifetime.”
The tone of such
investors is not one of panic. Rather, it is what psychologist
Martin Seligman has called “learned helplessness”: the sense that
one can no longer influence the outcomes of his or her life. It
forms, he believes, the basis for depression.
While
investors are looking for that high-volume spike as a sign of final
capitulation, they may be missing the very capitulation of
depression that is staring us in the face. But how can we prove this
market-depression thesis? For that, we turned to our market
psychologist, Dr. Brett Steenbarger.
Counting the consensus
The sentiment
surveys of Market Vane (see link in sidebar at left) are useful
tools for gauging optimism and pessimism, since they poll market
advisers and commodity trading advisers for their opinions of market
direction. Each week the surveys summarize the percentage of
advisers who hold bullish anticipations of the market. This
statistic is called the Bullish Consensus.
Steenbarger went
back to April of and examined all occasions in which the Bullish
Consensus had fallen below 30%. This was a rare occurrence. Out of
1,051 weeks, only 64 showed this extreme level of hopelessness. A
visual inspection of the dates, however, suggests that these
included some of the best buying opportunities of the past two
decades, including August 1982; July 1984; October 1987; April 1994;
October 1998; May 2000; March 2001; and September 2001.
According to Steenbarger, a shocking surprise can be found
in the distribution of the Market Vane readings. Of the 64 occasions
since 1982 when advisers have found little optimism, 40 of these
have occurred since the beginning of 2000! In other words, from
1982-1999, less than 3% of all weeks were characterized by adviser
hopelessness. From 2000 to the present, however, almost a third of
the weeks reached the hopeless level.
This is what we mean by
a “capitulation of depression.” In the past, hopeless readings on
the Market Vane survey quickly turned around; now those readings are
much stickier. Hopelessness feeds on hopelessness, as in Finney’s
tale. It isn’t well appreciated, but we are living through a period
of negativity of historic proportions -- the absence of high-volume
capitulation notwithstanding.
Health,
optimism and healthy optimism
So how do depressed markets
regain their health? Perhaps not surprisingly, in the exact same way
that depressed people do. Long before things get much better, they
stop getting worse. The selling and the negativity continues, but
stock by stock, sector by sector, issues stop making fresh lows.
Lost in the high visibility move of the Nasdaq averages to multiyear
lows is the fact that many indices -- from small cap ($SML.X)
to midcap ($MID.X)
to consumer ($CMR.X)
to cyclical ($CYC.X)
-- have remained staunchly above their September 2001
lows.
Why is this important? Because the last seven weeks of
readings in the Market Vane survey have all been below 30%. This has
never occurred before. And despite that negativity, a majority of
stocks have not exceeded their September lows. Things are still bad,
but they are not getting worse. At the height of last week’s
selling, we saw fewer than 150 annual new lows among New York Stock
Exchange issues. And for depressed markets, like depressed patients,
that is grounds for optimism.
You see, health -- of our
bodies or of the markets -- depends upon a healthy dose of optimism.
Studies by psychologist Seligman and other colleagues find that
people who fight off depression by changing their thinking patterns
subsequently experience greater physical health. They also take
better care of themselves and thus live longer. People with an
optimistic attitude, rather than one of anger or hopelessness, are
significantly more likely to return to normal activities within six
months after treatment of a serious illness. Why? Because optimism
bolsters the human immune system.
We believe that this may
be what is happening now, as in Mill Valley. A threshold level of
investors has developed immunity to the negativism of the pods, and
they are now helping keep the majority of stocks from sweeping to
new lows. Think of it: in the face of historic pessimism, more than
60% of NYSE stocks rest above their 200-day moving averages!
Someone, somewhere, is fighting the pods.
Standing firm
So that is why we are not
waiting on the sidelines for a high volume bloodbath that may well
not materialize. To be sure, investing would be easier if the market
handed us buying opportunities on a silver platter by leaving blood
on the street at each buying juncture.
The market, however,
is far subtler. It is like those pod people, lulling you into
waiting, pretending that the bears are your best friends -- until a
sustained rally emerges from out of the blue. At present, the only
question to us is whether there is enough fear in the market, enough
perceived risk, to induce one to believe that the returns in the
future will be rewarding. Our counts of the predictive properties of
myriad numerical measures -- the succession of 40-day lows, the move
in the CBOE Volatility Index ($VIX.X) above the critical 30% level,
the highs in fixed-income prices in conjunction with the decline in
stocks -- continue to lead us to believe it’s time to take a
stand.
We have every confidence that our own buying and that
of other optimistic market participants who refuse to give up will
waft stocks to higher levels. Our column came out on a Thursday, and
since that time the nine stocks we recommended have been
approximately unchanged: WorldCom (WCOM,
news,
msgs),
Charter Communications (CHTR,
news,
msgs),
Vitesse Semiconductor (VTSS,
news,
msgs),
i2 Technologies (ITWO,
news,
msgs),
Citrix Systems (CTXS,
news,
msgs),
Sanmina-SCI (SANM,
news,
msgs),
Nvidia (NVDA,
news,
msgs),
Dell Computer (DELL,
news,
msgs)
and Federal Express (FDX,
news,
msgs).
Still battling the pods, standing firm against seven weeks of
historic negative sentiment, we believe that those stocks, and many
others like them, are ready to roll.
Dr. Brett
Steenbarger contributed to this column.
At the time of
publication, Victor Niederhoffer and Laurel Kenner owned the
following securities mentioned in this column: WorldCom, Charter
Communications, Vitesse Semiconductor, i2 Technologies, Citrix
Systems, Sanmina, Nvidia, Dell and FedEx.
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