The Forces Behind Forced Selling
By James J. Cramer
02/03/2003 07:22
Forced selling, not fundamentals, creates most tradeable bottoms. You get forced selling from a variety of sources, and it might just help if you understand what they are.
First, the most obvious is when a hedge fund collapses. We saw dramatic forced selling in April of 2000, for example, which caused both the Dow and the Nasdaq to sink precipitously. We later learned that a couple of hedge funds were blowing out of the business and that created the bottom, which was tradeable to the long side for the listed stocks even as the Nazz soon capitulated. Sometimes these collapses can be created by redemptions; the recent collapse of Gotham Partners is a solid example. Sometimes it can be from an investment house trying to be sure it gets its collateral back before it vanishes.
Second, we get forced selling by mutual funds that have redemptions. We saw hefty amounts of this after Sept. 11 and we saw it repeatedly last year during the unwinding of Janus. Yes, Janus is still in business, but no, it doesn't have the same impact it once had because it is much smaller thanks to investors recognizing that there was no there there.
Third, you can get forced selling from institutions like insurance companies, because they have capital calls or have to repatriate capital. I believe that's what happened last week with the British life insurance companies, which were relentless sellers of our stocks. We have seen waves of foreign selling that can be unmitigated, particularly because the dollar has gotten weaker. That's what we saw in the summer of 1987. That's what we are seeing now.
Fourth, you can get forced selling from margined buyers being cashed out by the brokerage firms. We saw that all last year, the year before and in 2000. Now margin debt is so low that I don't think there is much more work to be done here.
I point out these distressed sellers because they are often the key to understanding why you get a rebound. Their forced, relentless selling is what makes the market become oversold, a favorable condition where other, more reasoned sellers say, "What the heck? I am no longer going to sell down here. It is too cheap." Their selling is what creates bargains. Their selling, however, is massively dispiriting because it defies valuation work. You could conceivably have to buy a stock that's down huge simply because one of its larger owners has to sell.
Understand that until the mid-'90s, we didn't have to deal with these unmitigated sellers in a serious way. No one owned so much stock that he could hurt the stock for weeks at a time on the exit. That is no longer the case; some sellers own amounts of stocks that would be considered foolish, if not outright crazy, a half-dozen years ago. It's why I try to size up the owners of stocks before I buy these days; I don't want to get caught in an Invesco redemption downdraft.
What I'm betting on right here with my Action Alerts PLUS money is that the forced selling last week trumped a lot of good news, as it often does, and made me feel that the market had reached a level where the nonforced sellers would be reluctant to sell. That absence of sellers coupled with a rise in the dollar might take the pressure off the insurers from London to dump more shares.
As much as we like to intellectualize and analyze every nuance of the market, it still comes down to supply versus demand, and I am betting that supply dries up down here.
The great thing about this game? We will know immediately if I am wrong! |
