Lately, I have been hearing a lot of market top/crash calls. These have been going on pretty much the entire rally off of the lows (recall the disastrous Hindenburg Omen). The most recent comes from respected fund manager John Hussman, who while having a bearish bend, has an actual methodology.
I am no stranger to making market calls, even if I think forecasts are pure folly. The Cult of the Bear series was an exercise in valuation and psychology, and I was surprised at the focus on the number (Dow 6800) while everything else was ignored. Even though that target was eventually proven right, the key to investment success is in the timing of your moves. (Note the cardinal rule of forecasting: Give a date or a level, but never both at once).
Which brings us back to the current environment. Broad indices are up over 100% since the March 2009 lows; economic indicators are mixed, with data improvements offset by a series of setbacks. These issues need to be contextualized against the massive liquidity wave from the Fed and other central banks.
What’s an investor to do?
My suggestion is to not guess as to where the market tops out, but rather, wait and watch the road signs. The market will give you lots of indicators that it is starting to stumble, than lose its balance, ultimately pratfalling. Even 1987 has a 14% drop in advance of the Black Monday 23% crash. In 2007-09, we received plenty of warnings before the market reached its 666 lows — down 57%.
Therein lay the rub. Recessions start not from lows, but from tops. NBER defines a recession “start at the peak of a business cycle and end at the trough.” Recall that in 2007, markets peaked less than two months before the recession began.
Hence, if you are an investor, you should not be thinking about when to jump out, and move to all cash/bonds position. Instead, you should be looking for a variety of signs that suggest it is time to lower your equity exposure as a function of rising risk relative to potential gains.
Indeed, the action most people engage is called market timing — jumping in and out based on expectations of an imminent crash or rally. Instead, I would suggest they would be better off eschewing market timing and instead focusing on risk management. This is a process by which the investor raises or lowers their equity exposure based on factors other than expected short term market returns. This means your goal is not catching tops and bottoms, but generating good returns on a risk adjusted basis.
At some point in the future, I hope to detail what these elements are. It is mostly mechanical, based on elements of trend, valuation, market internals, and economic factors. Until then, stop guessing what the markets will do, and start watching closely what they are actually doing.
~~~
Previously: The PermaBear to English Translation Guide (October 15th, 2010)
Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data, ability to repeat discredited memes, and lack of respect for scientific knowledge. Also, be sure to create straw men and argue against things I have neither said nor even implied. Any irrelevancies you can mention will also be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.
. . . . . you are invested with several metrics pointing to higher employment and, dare I say it, some healthy profit taking in treasuries.
Always logical, rational, and methodical. My money’s on you Barry (well technically, it’s largely with you).
I admit I’ve proven to myself that I poor predictive powers as to the direction of the economy and/or the markets. Therefore I must rely on others that do.
[...] Barry: Predicting market tops versus observing conditions. (TBP) [...]
BR explained
… market timing … risk management …
reply:
You say potato, I say potahto. (not really, I say it right, this is just an expression). How about you say thee, I say thou. Better.
Market timing is exiting on the way up and potentially missing some gain. Risk management is exiting on the way down and losing some profit. Both can leave at the same level. One just has their cash a little longer, amusing the market really does go down. Then again, I have seen reports of people buying bonds at the top without regard to why bond prices rise and fall. I’ve read reports of people buying stocks proudly in May 2011 because talk of liquidity disruptions when QE2 ended was considered nothing buy hooey deserving ridicule. I’ve read reports from asset managers who haven’t apparently noticed that bond and stock prices have an inverse relationship unless Fed policies temporarily interfere.
Since all investing by all investors and asset managers is nothing more than educated guesswork at best, all gains are free money and competitive investing is a distraction to making money. Anyone who beats the riskless rate of return is a winner. Anything else is gravy.
I consider the hardest part in valuation today the non constant accounting units we use. Euro, US Dollar, Yen or Swiss Franc, the currencies and their corresponding yield curves are so massively manipulated that it’s hard to tell if there actually have been gains in the equity markets or the accounting unit has just fluctuated.
I respect Mr. Hussman very much, but his reaching back to the 30s depression era dataset, while not taking into account modern radical policy reaction to that experience has done him a disservice. The same might go for inflation expectations and stock valuations through the 70s. We now know the ultimate outcome, investors then did not.
Too much mental capital is being spent on fighting the last war, instead of investing in real businesses with long time horizons and the ability to form capital.
Could someone explain how “respected” and “Hussman” end up in the same sentence. I sure don’t see see it after following his musings and his fund(s) performance.
I prefer to look at 1st and 2nd derivatives of 50 and 200 day moving averages. Barring any major geopolitical meltdown, there *usually* isn’t very much piecewise movement as Barry suggests: first “pre-fall” then crash, so oftentimes you can see it coming by looking at some choice indicators e.g treasury yields, index leaders, unemployment, cash reserves etc.
I’m relatively new to the game, but so far its been a decent strategy ^_^
” Wait and watch the road signs” ……….. Rest Stop Ahead, Dead End, One Way. Thanks BR!
You said…
At some point in the future, I hope to detail what these elements are. It is mostly mechanical, based on elements of trend, valuation, market internals, and economic factors.
I say…
Would love to see you post your thoughts on this in detail, please.
Barry: In your risk assessment, what, if any, consideration do you give to market valuation on a secular scale? Also, Hussman asserts that (historically) markets drop too swiftly for investors to “book” gains made during overvalued markets. Where does he go astray in concluding that?
Louiswi: Short term facts are not the same as medium term facts are not the same as long term facts. Barry’s discussion regards the end of this CYCLICAL bull market. Hussman (and Grantham and Schiller) focus on divergence from a projected SECULAR mean valuation. Hussman perfects the application of historical data. However, his process has failed to recognize that history is still being made. The “recent” history of persistent Fed stimulation resulted in Hussman’s failure to participate in recent cyclical bull markets because they largely stayed overvalued based on his secular scale. This does not mean Hussman’s secular prediction will be wrong, only that few investors will be with him when reversion to the mean finally prevails.
One way to do this is to have 70% equities and 30% TIPs. When equties gets to 75% or higher sell stocks and buy TIPs to get back to 70/30. When it gets to 65% or lower, sell TIPs buy stocks. Or you could rebalance once a year. Only use index funds or ETFs, guaranteeing that you get your share of the market returns.
This is Buy, Hold and Rebalance.
The NYA still has to make a post 2009 recovery high before anyone can even begin to think about a market top. The NYA will make a new high according to the Happy Family Theory of Markets.
ZedLock What do you mean by 1st and 2nd derivatives of 50 and 200 day moving averages?
This may sound trite and extremely unsophisticated, but is it not useful to see topping as a process and bottoming as an event?
From this perspective looking at a long term chart like the 10 month MA and more particularly its slope rolling over is a reliable indicator to perhaps dial down the risk?
Quoting: “louiswi,
Could someone explain how "respected" and "Hussman" end up in the same sentence. I sure don't see see it after following his musings and his fund(s) performance.”
His analysis is stringent and he is a weekly must read for me. He fails to anticipate policy response though, especially when it diverges from the optimal or logical path, as dictated by vested interests. I would say Mr. Hussman is a consummate analyzer who plays the board and not his opponent.
He will probably be vindicated, but that will take another severe collapse. Keeping clients in between will become harder, as the central banks have insured that one cannot earn money without bearing risk.
[...] Calling market tops/bottoms is for suckers. (Big Picture) [...]
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