Good article on capitulation :
globeandmail.com
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Investors dreaming of capitulation could be waiting in vain
By MATHEW INGRAM
Wednesday, July 17, 2002 - Print Edition, Page B8
Capitulation. Like Godot, everybody is waiting for it to arrive -- but no
one can seem to agree on what it is, whether it will ever come, and how
investors will be able to tell when it appears. In fact, the conventional
wisdom seems to be that investors won't know it when it occurs, and that
it can only be diagnosed in hindsight. It may even be the case that the
more investors want to see it, the less likely it is to show up.
Defining capitulation is a bit like describing a mythical beast, or
drawing a picture of an alien from the recovered memory of an abductee. In
most cases, the term is used to describe a vast wave of panic-driven
selling -- a frenzy of revulsion, in which investors decide that there are
no stocks worth owning at any price and that putting their money in a sock
is preferable to the pain that months of staggering losses have inflicted.
Every time the Dow Jones industrial average or the Nasdaq Stock Market
index goes through a day like Monday -- in which the Dow plummeted 440
points, only to recover virtually all that ground -- someone is bound to
whisper the "C" word. As soon as they do, someone else inevitably tries to
hush them up, so that no one notices what they said. Why? Because like
Godot, if everyone wants it, chances are that it will never arrive.
As a display of crowd psychology writ large, stock markets often suffer
from something like Heisenberg's uncertainty principle. Developed by
physicist Werner Heisenberg in the 1920s, this principle describes how one
can never accurately determine both the speed and the position of a
subatomic particle, because the attempt to measure either one inevitably
distorts the results (because of the measuring methods used).
So how does all this relate to the market? Simply put, investors may have
become so desperate to see signs of capitulation that their own behaviour
will prevent the massive selloff they are waiting for. The same paradox is
involved in contrarian indicators such as the investor sentiment index:
the more someone points to it as a buy signal, the less likely it is to be
a buy signal, because pointing to it causes it to disappear.
In a similar way, every time someone speculates that a day such as Monday
represents capitulation, they help to remove the chance that it is. To
make it worse, there are those who feel that searching for a climactic
wave of selling is a fool's errand, and that modern markets are likely to
experience dozens of smaller waves rather than a single event. As market
strategist Tobias Levkovich of Salomon Smith Barney put it recently, the
markets have already gone through "a multitude of mini-capitulations."
So does that mean stocks can go back up again now? No. Whatever happened
on Monday, it wasn't a big bell signalling the new bull market. It didn't
mean that in March, when there was an almost 400-point drop and rebound on
the Dow in a single day (March 22), and it didn't mean it in September,
when there was another 400-point drop and rebound. Incidentally, that
occurred on September 20, the day before the Dow set its 52-week low of
8,235, the one the index came close to breaking through on Monday.
Classic capitulation, the market watchers say, is a huge selloff similar
to Black Monday in 1987, when the Dow went into a freefall and closed
about 22 per cent lower -- not a one-day rebound of 5 per cent or so, as
we saw Monday. And even the selloff in 1987 wasn't exactly a screaming buy
signal of the kind some investors seem to be praying for. It took more
than two years for the Dow just to get back to where it was before the
crash, and a year later it lost most of that ground at the start of the
Persian Gulf war in 1990.
And the big selloff in 1929, the mother of all capitulation events? The
big freefall in October, when the Dow lost more than 20 per cent of its
value, took four days -- and the brief spike that followed was just a
prelude to another plunge. Another spike was followed by another plunge,
and so on. Did anyone mention the idea of capitulation during any of those
drops? Hard to say. In any case, it took three years for the index to
reach its low, and another 20 years after that to make up the lost ground.
The selloffs we've seen recently could be more like the period from the
mid-1960s to the late 1970s, when the Dow Jones average went through a
series of two-year peaks and valleys -- sinking in 1966, climbing back up
the hill by 1968, falling to an even lower point by 1970, crawling back
upward by 1972 only to fall even lower by 1974, climbing back by 1976 only
to collapse again by 1978, then struggling its way back only to fall even
lower by 1982. Talk about the market equivalent of water torture.
Whether they admit it or not, those who use the term capitulation probably
want it to be like August of 1998, when the Dow lost more than 1,000
points over four days and then climbed by 4,000 points over the next
couple of years to its record high of 11,722.
In that sense, investors want someone to call what the market is doing
capitulation -- or in fact to call it anything, so long as it means that
stocks will go up.
Mathew Ingram writes analysis and commentary for globeandmail.com
mingram@globeandmail.ca
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