Mar

12

The events of the last two weeks are startling and disruptive. No matter how many counts others and I adduce, that show that after a 5% decline in a week there is on average a 2.5% rise, relatively continuously over the next 10 days during the past seven years, someone's going to say that this one is different — the old rules don't apply. We have to go back to 1987 or 1929 of course, as the chronic bear weekly columnist said on March 2nd, when the March S&P was 1398.

He is bearish now because even his good friend who caught the decline was expecting a little rally before the ultimate swoon. As he said last week, there is a time to reap, a time to sow, and a time to panic. And that time is now.

In the back of our collective memories are the many occasions when a terrible end of world like decline such as this has occurred before, then there was a bit of a rally in the week following, and then subsequently a huge decline occurred again. Such a decline, which I liken to the tortures of the inquisition where they put you through one torture and then brought you back again for worse tortures when you thought that it all had ended, occurred subsequent to the May 2006 declines.

This also characterizes many of the big declines in 2000, when the NASDAQ 100 went from an adjusted 5209 on March 24th, to 4540 on April 3rd, up to 4742 by April 7th, but was then followed by a decline of 25% in the week of April 14th, and continued to plummet to 1600 by April 4th, 2001.

As I said when we compared those early 'naughties' declines to the end of the world, parts of the first movement of the Fifth Symphony, the melody, the hopeful march of fate, was rejoined. But there is the eerie knowledge for those who know, that Beethoven is not yet through with such despair. In this light, where counting is superseded by fear, I thought it might be helpful to turn back to something I am more expert at, the lessons that you might apply to this situation that you learned as a kid.

For guidance I turned to Roberg Fulghum , who said, Everything I need to know I learned in kindergarten . I also look to my own extensive training in street games: Street games have been designed to teach kids what they are going to need to know to succeed in life. I believe I am on firm ground here.

The first lesson to learn in street games is to look both ways. One can see the wisdom in this by seeing what happens if you don't look both ways. You're likely to be hit by a car, or almost as bad in truly competitive games, tagged out by the opponent who was hiding on your blind side.

After a decline of this current magnitude, one should always think about what could happen if the market continues to go down, or reverses and goes up. Are your positions so life threatening that a further small decline could take you out of the game? If so, it's only a matter of time until they do you in as the odds are about one in four that big cane calling declines will continue into the next week after the initial decline. You may only have a one in four chance of withstanding four declines in a row, but on the other hand, there is a three in four chance that you'll make money by keeping your position into the next week. And there is a 10% drift per year.

If you're not at the wolf point, like those who are in danger of margin calls might be, then by all means, this is a great chance to take account of the Dimsonesque ten thousand fold a century returns.

Another rule is to always put things back where you found them. If you don't put the equipment back after the game is over, you won't be able to play again. Or worse, you could be banned from playing at the night center, and then become x on the block, as often happened to me. When you have a position, and you're forced to lighten it due to money management, do get ready to put it back on as soon as your liquidity and ability to withstand loss is greater.

Perhaps you're one of those prudent people who have followed the message of the doomsdayists to keep 50% of your portfolio in fixed income. If now that bonds have gone up about 2% and stocks have gone down 5% you're 51% bonds 47% stocks, you have to do some switching and increase your stock exposure by 5%. Know when you do this that you will have the wind at your back, because in times like this when the estimated earnings yield is some two percentage points higher than the bond yield, the returns from stocks these years have averaged some 15 percentage points. You don't have to follow Abbey Cohen to get such a forecast for this, but merely turn to the Collab, Mr. Downing, and my quantification of this through regression forecast and bin analysis on our web site under the Fed model links .

One thing that all kids should know is to look out for traffic, but there are big boys who have every reason to go for broke when doomsday is in the air. First there are the chronic bears, those who are almost broke from fighting the almost 75% rise during the last three years — put a beggar on horseback and he'll gallop. Then there are those who have lost almost everything and will be taking no prisoners in their desperate attempt to get back their chips and reputation. They will be joined in this by the hundreds of billions of delta neutral money, and funds of funds with short exposure, who must or at least should justify their existence at times like this by pointing to the immense losses that those who played the long side only were exposed to during this squall.

One can expect them to pull no punches in mounting the pulpit to talk about how great their 5% a year returns in the last four years really are, compared to the 15% a year for stocks, because of such declines. They will certainly be joined in this chorus by the big trading firms who always have a bearish bias because they find so many things wrong with our situation that they accept the sacrificial egalitarian idea that has the world in its grip.

The problem is that these speculators will have to be particularly mobile around this time because stocks have such a high return relative to bonds, and because the public is beginning to believe that stocks aren't so bad after all, especially with the 6% earnings yield + 5% growth yield built into the average stock versus 4.5% 10-year bonds. If the market goes down gradually the public is going to come in and prevent the trading firms from getting out of their positions at a profit, so the only hope for the bearish forces is that their lieutenants can fan the flames of fear and take the market down so violently that the public will be too frightened to come in.

This brings us to a fundamental law of street games, which is not to panic. In the games of slap ball I played on a 25-foot long cross street on Brighton 10th court, and other venues, there was always one very big guy twice our age and size who could sometimes be induced to play. In my case it was Alfred Evaso who at fourteen, five foot eight and 150 pounds was twice my weight and one foot taller. He had a way of advancing to third when I was the catcher and then madly running like a steam roller for home on a steal. The obvious course was to panic. But wily players knew that the best way was to step out of the base path, yell for a pitch out, and take a fast pitch and tag him on the ass as he passed you. Such would be very helpful in the market as you wait for all days of decline to occur, and then come in at the close.

The final rule, from Fulghum this time, is to hold hands and stick together. In such conditions as these we have done well, as panic has not occurred and the call that it's every man for himself has not been given by the Captain.

Allen Gillespie adds:

My father always told me a bull market will try to scare you out, but a bear market will slowly devour you. The reason this sounds reasonable to me now is that bear markets relate to prolonged economic weaknesses; hence, time is a critical, but slow moving factor. Alternatively, bull market liquidation is all about margins and stops that are all quickly hit.


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