Stock Markets Fall – When Will We Have A Real Rally?

So. Monday’s rally was yet another dead cat bounce. From a close of 4256.90 (still below Thursday), the FTSE 100 has dropped back below the 4,000 mark.

I had a letter from a reader who raises a very good point:

"For long term buy and hold investors, this is the best buying opportunity for over five years but your recommendation is to sell three stocks (at what could be the bottom of a bear market). Your recent articles about whether or not this is a good time to buy were well timed. However, the practical action you are recommending (selling) seems herd instinct rather than contrarian to me."

He goes on to add that Warren Buffett and Anthony Bolton — both undeniably savvy investors — are both "putting their money where their mouth is".

I’d like to address this. Firstly, the sells. I’ve written here before that you should look to close out those positions you’re not happy to stick with for the long haul. In our case, we’re taking a hard look at our portfolios and removing those companies we think will be adversely affected in the coming economic downturn.

There are also stocks we’d like to replace them with. But the time isn’t right. Stocks that were screaming buys last week are screaming even louder today. We reckon they’ll be hoarse before long.

I’ve noted before that there’s a huge temptation to jump in and buy with stocks looking so beaten down. And it is undoubtedly true that many good companies will bounce back. If they’ve bought wisely, chances are Buffett and Bolton will, eventually, see positive returns.

But there are some important points to make here. First, Buffett has limited his activity to deals where he has negotiated very favourable terms. His purchase of a stake in Goldman Sachs was an example. Buffett is in a position that private investors are not. He can negotiate the right deal for him — we can choose only to buy or not to buy what’s on offer.

Second, Bolton wrote a piece in the FT at the start of the month explaining why he’s put money back into the market. The FTSE has lost about a thousand points since then.

I don’t say that to have a pop. Anthony Bolton is an investor for whom I have enormous respect. His record at Fidelity speaks for itself. And, yes, he is putting his money where is mouth is. Fair play to the chap.

But so are we. It’s just that our mouth is somewhere else. I take our reader’s point about a herd instinct. But we must bear in mind that — in the short-term at least — the prophecies of the herd tend to be self-fulfilling. I’d rather hang onto my money than satisfy a contrarian instinct just for its own sake.

As the markets climbed on Monday, Theo Casey wrote to Fleet Street Letter readers to sound a note of caution:

"Are the bargain hunters coming back to the market?

Maybe. But, and I may be starting to sound like a broken record, it’s still not time to ‘fill your boots’ and snap up all the bargains.

The reason is as follows:

I might sell into this rally...
A colleague of mine tells me they may sell into this rally...
And a friend working for a small cap broker in the City, tells me that they will definitely sell into this rally.

It’s what some people would call a sucker’s rally."

He was absolutely right.

I’m not a huge fan of trying to time the market. But let’s face it, if you start loading up on shares now, that’s exactly what you’re doing. You may tell yourself otherwise, but you’re money’s calling a bottom even if you aren’t (economists call this revealed preference).

So if we’re going to call a bottom, or anything like one, we need to have some solid reasoning behind us. Not just a gut feeling.

Our reasoning tells us this bear market has further to go. But we’ve by no means turned our back on equities. Quite the opposite. My colleagues and I are actively researching "recovery stocks" to buy and hold for the long run. We will also be making "surgical strikes" along the way — picking up individual stocks that look especially attractive. I’ll pass details along as and when they come my way.

But I reckon it’ll be a while before we get a bona fide stock rally. You see, odd though it may seem in the face of recent volatility, I don’t believe investors are fearful enough. Not yet... not as fearful as they should be.

We’ll be greedy when the time is good and right...

Why did the markets fall yesterday?

I try to avoid television news broadcasts. They seek to pack complex events into five minutes of flashy graphics and simplistic "Now you have something to say in the pub" explanations. They annoy me.

Last night, though, I caught the BBC 10 o’clock. Apparently, stock markets fell yesterday because of fears of global recession.

Excuse me? Global recession? Is that a notion that just popped into people’s heads for the first time on Tuesday night?

Of course not. What utter tosh!

Yes, some people are selling for that reason (as I say above, we ourselves have done exactly that). But that explanation, in isolation, is woefully inadequate to explain one day’s falls.

I’m not alone in being frustrated by this.

"I've heard lots of commentary linking falling equity markets to forward looking economic factors such as global recession," says colleague Andrew Vaughan.

"I think this misses the key point. When an investor has to sell shares to repay debt or a fund manager has to sell shares to meet redemptions, share valuations and future prospects become irrelevant. A forced seller is a forced seller. That is what is happening still. Forced liquidation. It would still be happening even if the economic outlook were rosy."

Andrew also adds that equity markets are being credited in some quarters as some sort of wise counsel:

"People are saying things like ‘equity markets fell, therefore the banking package seems flawed’ or ‘equity markets fell, confirming fears of economic slowdown.’ Equity markets are currently almost the only game in town for turning securities into desperately needed cash. That is what they are doing.

"It does not follow that they are passing judgement on all other events that are going on. Harsh to say, but the money that is still in equities at this late stage is maybe not the smartest money. Why should we interpret the markets’ actions as being wise counsel?"

As Andrew says, equity markets are ‘almost’ the only game in town for getting your hands on ready cash. Almost... but not quite...

Our commodities man Garry White tells me the same thing’s been happening with gold, which has slipped more than 2% today.

Uncertainty is still king, so investors will be pitched and rolled for a while yet. But it won’t last forever (even though, at times, it will feel like that). There’s still a lot of money to be made for patient long-termers. In fact, I believe the biggest opportunities of our lives are right ahead of us.

Garry’s confident, too.

"When markets start to normalise, he says, "I expect that once again commodity plays will be leading the charge forward."

Follow this link to find out how you can position yourself for this charge.

Until tomorrow

Ben Traynor
Editor
Fleet Street Daily

The Daily Reckoning — Why shouldn’t we have a meltdown?

Oh my...oh my...how much is a soul worth?

Yesterday was another bad day on Wall Street. After gaining more than 900 points on Monday, now the Dow has given back nearly all of them. The index fell 733 points on Wednesday.

Sell the rallies in stocks. Buy the dips in gold.

That has been our formula for this entire decade. It still seems to be working. But now the action is on the stock market side of the trade.

What’s going on? Hank Paulson is taking desperate measures to save his friends on Wall Street. Worldwide, the rescue effort is expected to cost more than $3 trillion. At least, that was the big number on the front page of the "Telegraph" yesterday.

You can read the Daily Reckoning in full here

P.S. If you enjoyed this article then we encourage you to sign up for the free Fleet Street Daily eletter. Learn what you can expect from today's markets -- and how to prosper in the face of uncertainty. You won't find more thought provoking writing anywhere on the Internet.

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Stock Markets Fall – When Will We Have A Real Rally?

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When Will We Have A Real Rally?