One of the first things that he notes is this:
"The broad movements of the market, covering periods of months or even years, are always the result of general financial conditions; but the smaller intermediate fluctuations represent changes in the state of the public mind, which may or may not coincide with alterations in basic factors."
The author then moves to a conversation between two traders. Essentially Trader 1 has covered his Steel short because 'everybody seems to be short.' Trader 2 responds that he thinks that everyone thinks just at Trader 1 and have also covered their shorts, but 'still the market doesn't rally much.. . I don't believe there's much short interest left, and if that's the case we shall get another break." Trader 1 then says, 'YEs, that's what they all say--and they've all sold short again because they think everybody else has covered. I believe that there's just as much short interest now as there was before." (p. 8)
I don't know about you, but I was laughing at this point. The author notes, 'It is evident that this series of inversions might be continued indefinitely. These alert mental acrobats are doing a succession of flip-flops, each one of which leads up logically to the next, without ever arriving at a final stopping place."
Now here is the real gem, and we would all do well to heed it:
"The main point of their argument is that the state of mind of a man short of the market is radically different from the state of mind of one who is long. Their whole study, in such a conversation, is the mental attitude of those interested in the market. If a majority of the volatile class of in-and-out traders are long, many of them will hsasten to sell on any sighn of weakness and a decline will result. If the majority are short, they will buy on any development of strenght and an advance may be expected." (p. 9)I'll close this post with a couple of key points, that I'll take verbatim rather than trying to paraphrase:
"The psychological aspects of speculation may be considered from two points of view, equally important. One question is, What effect do varying mental attitudes of the public have upon the course of prices? How is the character of the market influenced by psychological conditions?
A second consideration is, How does the mental attitude of the individual trader affect his chances of success? To what extent, and how, can he overcome the obstacles placed in his pathway by his own hopes and fears, his timidities and his obstinacies?" (p. 9) (emphasis added).
I know that these statements are common sense. But seeing them plainly gave them so much power for me. Now, understanding how this colors the market and the opinions that are tendered daily is more art than science.
While I'm in the camp that the economic fundamentals are not as great as some say, over the last month, I've consciously tried to find some sectors that I think will still work regardless. So I put a lot of energy: specifically the drillers and coal plays. I'll say that seeing some success in this has meant quite a bit to my mental attitude. These are cheap areas--so even if there is a market downturn (which I'm still waiting for), (1) these are inexpensive stocks whose value in this energy environment will increase; and (2) because they are cheap, they have less far to fall.
13 comments:
Another thought to keep in mind is that in many cases, one has a pre-conceived notion about which direction the market is going, and then finds the public opinions or blogs or selective facts that support the original theory, all the while discounting the opposite viewpoint. This is why someone will wait and wait before making a move, usually ending up being too late in the game.
As an example, I read Bill Cara everyday among others, and I truly believe his enormous ego is getting in the way of the facts that are in front of him. He has been predicting the Dow at 8800 since late '05!!
I gather you are somewhat bearish too, but for the life of me, I have yet to see anything that signals we are in for a major turn in the near to intermediate future. If the facts such as weakening employment, weakening GDP, flat or falling core inflation, falling commodities, and a few others come out, it may be time to think about playing defensively imo.
Then again, as a trader, you rely on nimbleness to get in an get out. How you manage to keep your sanity in that mode of operation is a gift.
Angela--I've concluded that no one knows which way the market is going. Further, the same "facts" presented to smart, reasonable people, oftentimes lead to different conclusions. I think that Bill is an honest voice with tons of experience and integrity. I don't think of his having an enormous ego, and I appreciate his generosity in speaking his mind and sharing is knowledge.
"I have yet to see anything that signals we are in for a major turn in the near to intermediate future." Who really does see these except some of those voices on the periphery with their tablets bearing the inscription "the end is near"! What is really instructive and really quite frightening is to read actual quotes from accepted thought leadership about the "nature" of the current correction. I can probably get some out of a book, and I'm sure folks here have seen it.
In the end, it comes down to our listening to all the voices and making decisions that make sense for our risk profile. I'm keep my own personal tally about my thoughts regarding interest rates, subprime and housing. So far I'm batting 1000. Now, my batting average suffers mightily relative to the stock market's (general, not sector specific) reaction to it.
The overall global liquidity situation is fueling so much of this. Keeping our eye on that will help us keep a watchful eye on this stock market pot!
Angela-
Did you see anything that suggested a turn on February 27? Has CNBC convinced you that was a one-off event? They don't ring bells at the top.
Leisa has the best advice: assess the risks yourself and position accordingly.
This looks and smells an awful lot like 1999 to me, sans Prince. M&A and a relentless money pump are keeping equities afloat.
Good lucka nd good trading.
FD: Long and hedged.
More FD: Enormous ego.
MarkM
Oh dear, it looks like one of the Little People has awoken from his trance.
I don't watch CNBC during the day and also not when I get home from work. I usually try to catch 30 Minute Meals or Semi-Homemade Cooking and after dinner, I catch up on my internet reading. But before I let this issue go, the only difference between CNBC and BC is the CN. Isn't that an abbreviation for "Canadian"? And as a further aside, BC discovered Nouriel Roubini by watching CNBC, who happens to have the most incorrect opinions about macroeconomic events of any economist who I have ever seen! Who is following the advice of whom here?
MY issue is not who's advice to follow, but to read events and facts and put them all together that result in intelligent decisions. The goal is to ignore opinions and not follow them. How do you know the opinion makers are smarter than you? And technical analysts? They are one level closer to crystal ball readers and carnival barkers.
Sticking to facts here...Feb 27 was a non-event. So was October 19, 1987, and so was the last week of August, 1998. One look at a 10 year chart of the S&P 500 before and after the historical dates will tell you they were non-events. This isn't rocket science, bub. There were macro events in the weeks before 2/27, and yes, BOJ raised their rate to 0.50%. But other than a few finance ministers flapping their jowls, nothing has changed. Next week might be different, but I don't brag about having a crystal ball, and I certainly don't have an ego, which WILL definitely get in the way of any rational thought. I surely wouldn't brag about having one in my FD.
Looking at the charts again, I see that the S&P500 was up over 20% in 1999. What was the issue there? As I recall, Greenspan mis-read the economy and raised rates one last time in 2000 to the point where he was a couple points higher than core which killed all the fun. Or did he do it on purpose to prick the bubble? 'Ol HB&B out to screw the little guy again, lol.
Yes I agree with your final conclusion: assess the risks and then make decisions. How you personally choose to assess risks is where the errors are made.
If a majority of the volatile class of in-and-out traders are long, many of them will hasten to sell on any sign of weakness and a decline will result. If the majority are short, they will buy on any development of strength and an advance may be expected.
That quote bears repeating as I think it is the latter which currently obtains in this market. Despite the unprecedented positive movement in the indices, the short interest is very high in many stocks and, as Selden describes, is driving the market higher.
AS for Bill Cara, it's a testament to his value to individual investors that even skeptics like Angela read him every day.
Me, I wish I'd paid better attention to him about the oversold conditions in the home builder stocks late last summer. I would have retained a lot more of my early profits.
And he and his many expert commenters have been absolutely invaluable with regard to the movement in the precious metals.
I've sent a private message regarding some of the content.
Angela states:
"MY issue is not who's advice to follow, but to read events and facts and put them all together that result in intelligent decisions. The goal is to ignore opinions and not follow them. How do you know the opinion makers are smarter than you? And technical analysts? They are one level closer to crystal ball readers and carnival barkers."
The problem is that there really are so few facts that lead to incontrovertible conclusions. So while YOUR goal is to ignore opinions, it's over-reaching to say that it is THE goal.
I value the opinions of others. And the opinions that I often find the most valuable are those that are contrary to mine. It's the contrast that forces the due diligence of supporting one's own opinion. Understanding the substance of another's argument, helps one ensure that s/he understands the gap in his/her own argument.
Was 2/27 a non event? That's your opinion. For me it was not a non-event, but rather a reminder of the interdependency of the markets, that many seemed to have forgotten--a shot over the bow if you will.
I suppose that one can look at the dips in the indices and declare that any of them were non-events, but you are looking at an average market. Some of these "non-events" set people back remarkably more than those averages.
Overall, the point is to ensure that one's portfolio is situated in such a way, with enough diversity to withstand a market shock without having it devastate their wealth. Unfortunately, many people never understand that risk in the market during the "boom times" is high. I know that I didn't.
Wow, no ego there! LOL. Must be LONG AND STRONG from my read.
That 47% haircut from stratospheric PEs must have been one fun ride on the SP500 train to Long Term Investor Heaven. Man, wish I coulda been there. Sounds like fun. 1999 was the setup as PEs went from what, 30 to 42? I'm going from memory here.
Sure Bill's bearish. Bearish signs abound. Some bullish ones too. None bigger than Capital "T" Trend. Big Mo is in there too. And The Great Money Spigot.
BIG believer in mean ol' Mean Reversion, me. PEs. Profit Margins. Earnings. Volatility.
Has always worked before. But maybe this is the first "new" New Era. I sure read alot of stories saying so.
Would have loved to have seen that deleted post. Must have been a doozie. Maybe even Woodshed material.
Sorry my post offended.
MarkM
Hey Mark,
I'd love to talk about the deleted post but I promised Leisa that I'd be good from now on :P
You have data on PE's? Can you tell me what the forward PE was in the S&P 500 for 2006? And for the first four months of 2007? And also, what was the average annual PE for the S&P for the last 20 years?
I'm not talking about reported earnings, which is a useless stat; I'm talking about operating earnings here.
Many thanks!!
Angela, you've invoked the "accounting goddess"![said with all goodwill!]
GAAP earnings are not a useless stat v. ops earnings. In fact, if you poke around in the differences between GAAP v. Op earnings you can find lots of interesting things that speak to management's competency. Now it can be in favor of GAAP or in favor of OPs, but the important thing is to LOOK at the differences and then make a judgment.
One example, interest expense (not included in op earnings). has brought many a company to its knees.
Regarding forward earnings--I consider that pretty close to useless as it is based on management's estimates--and those have been known to skip a beat or two. I'll hold the homebuilders and chip makers as the two most recent examples of where forward estimates have been pretty ineffectual.
Leisa,
Touche, mon ami.
"Useless" for my data-nut purposes only, I should have clarified. I have found that forward operating earnings of the S&P are a good indicator of whether or not the market averages have a healthy underpinning or if we are dancing on banana peels. At the moment, the PE is about 16; historically, the average is 18 to 20. In 2000 operating PE was about 29 I think. I don't have those records in front of me, but I believe thats where it maxed out. We aren't anywhere close to the precarious point from back then, and are actually a little below the average. Thats a good sign in my book.
I'm guessing Mark's "30 to 42" is reported PE's. For the S&P, those numbers have had more historical variation from year to year, making it more difficult to catch a trend.
Angela, I did a little digging regarding your p/e musing. Regarding the level of p/e levels, John Hussman writes about it here.
He makes an interesting argument in that if you look at historic p/e ratios, they are distorted because they include depressed earnings resulting from recessionary effects. He also notes the recurring apples to oranges comp of trailing P/E based on net earnings against the forward p/e based on operating earnings. Kind of like shopping for groceries and you have two packages with different quantities, but one looks like the greater bargain! Since I'm math challenged, I always take a calculator with me to avoid being fooled.
Now, I'm not a trying to be a fact checker here, merely a conduit, but Hussman's answer to Angela's question regarding the current p/e ratios "the current price/peak earnings ratio is about 17.5, well above the historical average of 14 for the price/peak earnings ratio."
"Valuations Revisited
Long-time readers will recognize some of the following arguments from various studies I've presented in recent years, but I believe that it is important for investors to understand how profoundly incorrect and potentially dangerous it is to accept the incessant argument that stocks are cheap on a "forward operating earnings basis." As AQR's Cliff Asness has previously noted, the belief that the current “price to forward operating earnings” multiple is reasonable is based on an apples-to-oranges comparison. It is the trailing P/E on reported net earnings that has a historical average of about 15, not the forward P/E on estimated operating earnings (which Asness estimates as having a historical norm closer to 11).
If we look closely at S&P 500 earnings, we find that we can draw a 6% growth trendline connecting earnings peaks from economic cycle to economic cycle as far back as we care to look. So even though earnings sometimes grow rapidly from the trough of a recession to the peak of an economic expansion, at rates sometimes exceeding 20% annually, we also find that the peak-to-peak growth rate has been very well contained historically at just 6%.
Unfortunately, if we a) calculate the S&P 500 price earnings ratio based on those “trendline” earnings or b) look at periods where actual earnings were within 10-20% of that trendline connecting historical earnings peaks, we find that the average S&P 500 price/earnings ratio drops to just 10.
Currently, S&P 500 earnings are again at that trendline. In fact, given the unusual spike in profit margins, they have actually moved slightly (but not significantly) above that line. On that basis, the current price/earnings ratio, normalized for the position of earnings at present, is about 75% above its historical norm (alternatively, the historical norm would be about 40% below current levels).
That's not, by the way, the level at which we would observe deep undervaluation. The extreme 1974 and 1982 troughs, for example, occurred at price/peak earnings ratios of 7 and price/trendline earnings of about 6. Given the current multiple of 17.5 times those trendline earnings, I am certainly not suggesting any probability of the market moving to such levels. But to rule out a decline of 30-40% on the S&P 500 would be to rule out a move to valuations that have historically been standard, normal, commonplace."
Forward operating earnings as predictive, eh, that's the muck that I'm asked to step into? Catching "trends" with that are we? I'd ask when you step off the Happy Train with that one. When your measures reach 20? 21? 22? Or some other valuation that mean that your portfolio has a duration of about 60 years? Is 29 now the sceret number? And what is so special about the last 20 years except for the fact that they have contained a period of persistently elevated PEs? Are you arguing New Era/ New Valuations for stocks here? That it doesn't matter that you are paying ever increasing prices for an instrument that represents nothing more than a claim on a future stream of payments? That didn't seem to work in 2000. Or in 2001. Or in 2002. In fact good ol' T Bills have creamed stocks for the last 8 years that's what elevated PEs gets you. Or maybe profit margins will not mean revert! Or profits either! Gloriously higher through globalization and cheap money. Except if that happens, as they say, capitalism is dead.
MarkM
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