"Bernie Schaeffer: Warren Buffett's Poker Tips Plus: "If You're So Rich, Why Aren't You Smart?"
By Bernie Schaeffer
9/20/2002 9:41 AM ET
I'm writing this with one eye on the TV, checking the overnight market buzz after yesterday's wipeout. And I'm struck by the fact that financial media pundits now glibly refer to "the VIX" and to "the wall of worry" and to "selling climaxes."
This is both encouraging and downright frightening. It's encouraging because some important sentiment-based investing concepts have finally been absorbed. Five years ago when I was regularly using these terms in my media interviews the reactions ranged from the blank stare to the look that said, "I know you just landed on a spaceship. Is your planet in our solar system?"
This was during the heart of the bull market of the 1990s, which was replete with sharp and scary pullbacks. I would explain how bull markets always climb a wall of worry and how bull-market pullbacks can be scary to most investors but actually provide fine buying opportunities and how high CBOE Market Volatility Index (VIX - 45.02) levels indicating high investor fear levels are a bullish indicator. And guess what? These explanations came across as a bit flaky, as in "The market dropped 300 points yesterday and the sky is about to fall and this clown thinks this is good?"
Fast-forward to this morning. No longer do the media mavens have trouble with the concept of negative investor sentiment being a bullish contrarian indicator. In fact, that's a huge chunk of what is being discussed in the wake of yesterday's visit by the Dow Jones Industrial Average (.INDU - 7964.90) into "below 8000 land."
And here's the frightening part. This particular market analysis ("investor fear = market bottom") that worked like a charm during the bull market of the 1990s is no longer the solution. In fact, it has become a major part of the problem. Why? Because we're deep into a bear market. And in bear markets, investor fear and market volatility and wholesale dumping of stocks are to be expected. And while such situations can present trading opportunities, they seldom represent the ultimate market bottom except in a rare case that I'll discuss in my closing comments.
Remember the September 21, 2001 "bottom?" There was near-absolute certainty in the minds of the investment community as we moved out of that deadly month that the worst was behind us. And much quoted in the rationale for this "market bottom" were the half-learned lessons from the 1990s bull market, i.e., the belief that "high investor fear levels" guarantee a bottom.
Why do I refer to this lesson as "half-learned?" Because the power of contrarian sentiment analysis is derived not from focusing solely on sentiment on market declines. One focuses instead on the sentiment on counter-trend moves. In bull markets, the counter-trend moves are to the downside, and it is a bullish contrarian indicator when there is an excess of investor fear on such moves. In bear markets, the counter-trend moves are to the upside, and it is a bearish contrarian indicator when there is an excess of investor complacency on such moves.
Has there been an "excess of investor complacency" on the rallies off the September 21, 2001 and July 24, 2002 "bottoms?" Surely you'd be jesting by asking this question if you're a regular reader of this space or if you follow the daily market observations of my analyst team. With so much having been detailed in our various commentaries about this disturbing complacency, I'll mention just a few recent examples.
The excess of bullish-over-bearish newsletter pundits in the Investors Intelligence weekly compilation is currently about 10 percentage points and was as wide as 14 percentage points in late August.
The CBOE equity put/call ratio 21-day moving average plunged from a peak of 0.76 in July to a low of 0.56 in August as options traders rushed to buy calls in the wake of the July "market bottom."
Wall Street strategists currently recommend a 69.6-percent portfolio allocation to stocks, down just a tad from their record high recommended allocation of about 72 percent during the bull market. And this 69.6-percent allocation is a full 10 percentage points higher than it was during boom times in September 1999.
Despite the market carnage that has occurred over the past year, the short-interest ratios (short interest/average daily trading volume) for both the NYSE and the Nasdaq have been essentially flat.
Seat prices on the New York Stock Exchange remain near record-high levels.
But, undaunted by this mega-complacency in face of one of the worst bear markets in modern times, the "usual suspect" analysts and the pundits instead display a not-so-subtle sense of superiority when they prattle these days about what a good omen it is that investors bailed out of equity mutual funds in July. And "how about that high VIX?" as in "it looks like those options fools are going to give us another market bottom."
You've been waiting patiently for my Warren Buffett take, so here it comes. As Mr. Buffett once so aptly put it: "If you're in a poker game and you can't figure out who the patsy is, then you're the patsy". And in the throes of a bear market, the public who is redeeming their mutual funds and bidding up the VIX to high levels and fearing for the sake of their jobs and the economy is the smart money! And those smug pundits who five years ago wouldn't have known a "VIX" from a Twix and who now turn their nose up at the "dumb panicky public" are - you got it - the patsies!
And (back to the title of this piece) while no one doubts that Wall Street analysts and pundits are rich, we have every reason to doubt they are smart as regards calling a bottom in a bear market. As for their wealth, let's just say I have my doubts that it emanates from successfully trading stock index futures.
Early on I stated that there is a rare case in which climactic investor fear would in fact define the bottom in a protracted bear market. What would this look like?
Forget "high" VIX numbers like 56 and 57. At a climactic bear market bottom, the VIX will come in north of 100, as it did in October 1987. I'm glad you asked - the VIX peak in October 1987 was 172.79.
The CBOE equity put/call ratio 21-day moving average will post readings in excess of 1.00. The highest such readings since 1990 have been in the 0.75+ area.
There will have been many consecutive months of equity mutual fund redemptions, climaxing in an off-the-charts single-month figure.
In other words, if the bear-market bottom is, in fact, climactic, we will not have a mere "extreme" of bearish sentiment - we will have an EXTREME!!! of bearish sentiment.
And where will the Dow be when this occurs? In my opinion, at 6000 or south thereof.
- Bernie Schaeffer" |
