Investment Strategy : “Buy and Hold Is Dead?!”

Investment Strategy

By Jeffrey Saut | 2 December 2008

"The other reliable indication of the start of an upward swing is afforded when, after a period of declining prices or, less frequently, dullness, the market advances or refuses to go down following the receipt of bad news. It is not enough that there should be temporary strength in these circumstances; the best of the market position should be applied for an entire day, and stocks should be bought only when, after thorough dissemination of unfavorable news, the market finally advances above the point where it was before the news was received." ……Don Guyon, from the book "One-Way Pockets"

"One-Way Pockets" was written by an unknown author using the nom de plume of Don Guyon. The book was first published in 1917, while we first encountered it in the 1970s after hearing it was legendary strategist Bob Farrell’s favorite book on investing. The aforementioned quote, which can be found on page 36 of said book, seems to be as insightful today as it was 91 years ago because human nature doesn’t change.

Speaking to "the market advances or refuses to go down following the receipt of bad news," two stocks that have been in a death spiral for months "coughed up" some pretty horrific news recently, but their share prices actually went up. Not only did they rally, Citigroup (C/$8.29) has gained 172% since a week ago Friday while General Motors (GM/$5.24) tacked on 136%. Moreover, since the October 10, 2008 "capitulation alert," the economic news has been dour yet stocks have not meaningfully traveled lower. As Barron’s noted a week ago:

"For a bullish spin, though a weak one, the market has not made a significantly lower low since October 10th. The word ‘significantly’ is important because some major market indexes, including the Nasdaq, have indeed been setting new lows. But the trend, if we can call it that, has been more sideways than decidedly down. A better, but still weak, bullish angle comes from trading volume, or the amount of money committed to either the bull or bear side each day. All of the higher volume days that have occurred since October 10th have come on days when prices rose. Theoretically, when prices are going up and volume increases, it means that investors are chasing the market higher. That's a sure sign of demand. Subsequent declines occurred with lower volume, so we can conclude that the desire to sell was not quite as strong as it was before October 10th."

Recall that on October 10th that of the 3,130 stocks traded on the NYSE, a shocking 2,901 of them made new yearly "lows." Accordingly, that 92.7% "new low" ratio registered the first "capitulation alert" in decades. Interestingly, all subsequent lower price readings for the major market indices were accompanied by "new low" ratios nowhere near as austere. And, when the DJIA’s (8829.04) nadir arrived on November 20th, of the 3,271 stocks traded on the NYSE that day, only 1,894 made new yearly lows (a 58% ratio).

Further, at those November lows the S&P 500 (SPX/$896.24) had lost some 52% of its value since its October 2007 "high." Categorically, I can find nowhere in the market’s history where the major market averages have fallen by 50% and there has not been a 'substantial' [[more than a week, anyways: normxxx]] "throwback rally," even if the averages eventually went lower. Additionally, while the S&P 500 marginally undercut its 2002 price lows, the DJIA did not, and that’s a huge downside non-confirmation.

When such pricing action is combined with other metrics, like the oft-mentioned oversold condition, the Volatility Index (VIX/55.84) closing below its 50-day moving average, the extremely bearish investors’ sentiment readings (read that as bullish), the lowest percentage of analysts’ "buy" ratings EVER [[also bullish: normxxx]], etc., was it any wonder that over the past five sessions the S&P 500 registered one of its best weekly skeins in history? As our technical analyst Art Huprich presciently wrote a week ago:

"As a result of Friday’s action, which I think was very important psychologically, the SPX recaptured its breakdown point of 768 (2002 low), after only one day. This is why I felt it was better to wait until the end of the week and possibly this month, before passing judgment. I still feel that way! Consequently, I am not yet willing to say that the SPX has violated its 2002 lows. I believe the SPX and DJIA are at critical inflection points! Within the context of a long-term ‘structurally fair’ market, in which the DJIA moved sideways for a decade or more, similar to 1966 to 1982, 1929 to 1949, and 1901 to 1915, in light of testing five to six year lows, this is a spot for a stock market bottom to attempt to form."

Inferentially, another important observation can also be gleaned from the book "One-Way Pockets." To wit— at the top of bull markets participants want to be investors; at the bottom of bear markets participants want to be 'traders'. To this point, the media is recently replete with the mantra, "buy and hold is dead!" I heard it numerous times again last week, and when one particularly wrong-way wonk uttered it, after being bullish for the past 10 years with a buy and hold strategy, I found myself screaming at the TV screen, "Jack, you are an idiot!" Ladies and gentlemen, the time to be a 'trader' was a year ago, not here at the best valuation metrics seen in a decade. As Société Générale’s James Montier states:

"This is a value investor’s version of heaven. From a bottom-up perspective, the equity market is offering some excellent companies at truly bargain prices for those with the fortitude to shut their eyes, or at least switch off their screens and buy. With all these opportunities available I have never been more bullish. Will I be early? Almost certainly yes, but if I can find assets with attractive returns and I have a long time horizon I would be mad to turn them down."

Even a somewhat more cautious Barton Biggs of Traxis Partners recently stated,

"I have no idea when the next bull market starts, but I do think we are setting up for the mother of all bear market rallies. Stocks around the world are cheap, stock markets have been obliterated and are deeply oversold, the fabric for economic healing is developing, and we must be pretty close to maximum bearishness."

Plainly we agree, which is why we have been recommending that accounts position themselves accordingly since the October 10th "capitulation alert." More recently, we noted a "capitulation alert" was registered for commodities as well.

The call for this week: Last week Wall Street experienced one of its biggest weekly gains since the five-day surge that ended the great bear market of 1929— 1932. We think the "lift" was driven by America’s new regime, as well as the Citigroup bailout, which unlike the previous bailouts did not wipe out the equity holders. According to the good folks at Bespoke, however, following such skeins the markets historically have retreated the next week by 2.4%. Nevertheless, we have had ten 90% downside days since September 2008. Then on November 24th we had a 90% upside day.

Based on the 70-year history of Lowry’s data, a series of 90% down-days followed by a 90% up-day often signals the end of a bear market. Like Barton Biggs, we too don’t know when the next bull market will begin, but if the DJIA can better its November 4th high of 9625.28, and is confirmed by the D-J Transportation Average (DJTA/3215.20) besting its November 4th high of 4071.81, it would certainly be a step in the right direction. Whatever the outcome, we have, and continue, to treat the October 10th "capitulation lows" as a bottom for the short-to-intermediate term, until proven wrong. Still, this is the most difficult market we have seen since the 1970s, which is why we are employing a hedging strategy and continue to emphasize clean balance sheets, decent fundamentals, and dividends. We continue to invest accordingly.

[ Normxxx Here:  WARNING— Bears be EXTRA cautious here!  ]

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Normxxx    
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