The Pendulum is Swinging! June 21, 2002.
Like those that preceded it, this bear market surely won’t end until all the excesses of the bull market have been reversed. That is what the term ‘market
correction’ means, the correction of the previous excesses.
That doesn’t mean correcting just the excesses in stock prices and valuations. The pendulum also swings in investor psychology, from extremes of
confidence and greed at bull market tops, to extremes of uncertainty and fear at bear market bottoms.
That’s easy enough to understand. As I warned in my 1999 book, Riding the Bear – How to Prosper in the Coming Bear Market, “In bull markets the
gains are exciting and intoxicating. It’s great fun to constantly check the market to see how much is being made. It’s all so easy, and a real high to discover
that there really is a quick way to get rich. The stock market becomes an obsession, the subject of conversations around the dinner table, at cocktail parties,
around the water cooler, everyone competing with boasts of how much they’re making. However, comes the other side of the cycle, the bear market, and
suddenly the stock market is no fun at all. In fact it’s incredibly painful and fear-inducing to see previous gains disappear so quickly. Soon there is no joy
in discussing the miserable market with anyone. The previous daydreams of riches become nightmares. The previous euphoria becomes despair.”
In 1999 the latter situation seemed impossible to even imagine. It was a new era and the good times would continue forever.
But that old pendulum never stops swinging. Sometimes it catches a tailwind and swings a little further and a little longer in one direction, but it does keep
on swinging. From the 1987 high it swung too far to the downside, with the 1987 crash quickly followed by the 1990 bear market, and then the flattest four
years in market history from 1990 to 1994. So it’s swing back to the upside lasted longer and swung all the way up into the biggest stock market bubble
since 1929. Not surprisingly then the swing back in the other direction has lasted longer than the 14 months that have been the average duration of bear
markets over the last 100 years. This one has already lasted 27 months.
However, so far, with stocks still selling at historically high price-to-earnings ratios, the pendulum hasn’t swung far enough to bring stock prices back
down to fair valuations. And with investors nervous, but not yet having “sworn off the damned market for good”, the pendulum has not swung far enough
from greed to fear in investor psychology for the bear market bottom to be in. But it is making considerable progress in that direction, as can be seen by
the continuing outflow of money from mutual funds, and plunging trading volume. The falling U.S. dollar also has foreign investors beginning to pull
money out of the U.S. market. The U.S. dollar has declined 10% in the last 3 months, while the S&P 500 has also declined 10%. That gives foreign
investors an additional 20% loss when measured in their own country’s currency.
The pendulum is also swinging in the reversal of the power and adulation that investors showered on Wall Street analysts, corporate chiefs, and financial
media ‘stars’, believing their every pronouncement that stocks could only move higher. The bear market won’t end until the pendulum has knocked those
idols off those pedestals, and they have been thoroughly beaten into the ground, even into disgrace. And that process is certainly moving along, with
investors distrust of Wall Street and corporate management reaching the point where even good managements are being distrusted, understandable with
every day bringing disclosure of yet another scandal, timely resignation, or disclosure of illegal insider activity.
Meanwhile, many of Wall’s Street’s most famous self-serving analysts have either disappeared into a mire of lawsuits, retired, or been moved into less
conspicuous positions. TV financial shows that provided the publicity and hype that vaulted those analysts into stardom have gotten religion, now
conducting more probing interviews, and even having great fun ridiculing analysts’ previous pronouncements and track records, conveniently forgetting
they were the ones previously promoting those pronouncements to their viewers as valuable information.
Congress, and the Securities and Exchange Commission (the supposed watchdog of the securities industry), have finally awakened, and are making new
rules, as they have in the past only after the damage is done.
So the pendulum is swinging toward conditions that prevail at the end of bear markets. And it is at the end of bear markets, not in the tail-end excitement of
bull markets, that investors are presented with once in a lifetime investment opportunities. But the pendulum has not swung far enough toward undervalued
stocks, and toward investors being so pessimistic they give up and are no longer interested, or paying attention, when the bottom does arrive.
So keep that in mind if a significant summer rally begins soon, as I expect one will. Rallies in bear markets provide opportunities for substantial quick
profits, but the time for buy and hold investing is still a ways away.
Sy Harding |
