Behavioural financial analyst Ken Norquay believes managers of big portfolios are ‘concerned’ about the market. But they have a liquidity problem. Selling will depress the market. Small investors don’t have liquidity problems. Even with a few million dollars in stocks, you can sell without disturbing the market in the least. If you are ‘concerned’, sell now.
Many investors are familiar with legendary Merrill Lynch analyst Robert Farrell’s famous concept: “The Three Cs of a Bear Market”. Mr. Farrell described the overall mood of investors during stock market down trends of 30 per cent or more, as:
In the Complacency Stage, investors see that the stock market is going down, but don’t really mind. Often they will rationalize: “It’s just another correction.” Complacency is the overall emotional tone of investors in the early stages of long-term down trends in the stock market.
In the Concern Stage, investors are no longer in denial about the trend: everyone understands that it’s going down. They are concerned. Will my long term financial goals be met? Will I have enough savings to retire comfortably? This concern appears in the middle part of the decline.
The Capitulation Stage refers to that part of the decline when investors decide to take defensive action and sell some or all of their stocks. They give up en masse. They suspend belief in the long-term up trend and sell. Capitulation occurs at the end of the decline and is the cause of the steep, climactic sell-off that normally accompanies stock market bottoms.
How do you feel?
It is not just average investors who feel these emotions. It is also the mega-investors, the portfolio managers of mutual funds and pension funds. Small investors do not influence the market much; it’s the big money that makes it move. Sometimes we are told that professional investors always make their decisions based on rationality and reason, and not on emotion. This is not true: they are emotional humans too. The difference is not in what they feel—the difference is how much money they control.
My question to investors at this time is: Are you complacent or concerned about the market right now? Sit quietly by yourself and try to feel your actual attitude about your investments right now. Are you complacent or concerned? Make a mental note: we will ask you to refer back to this note as the market bottom approaches in a year or two.
Mutual fund sales people are ‘concerned’
I have observed that professional mutual fund sales people are concerned. Several ‘advisors’ are writing about ‘volatility’ and reminding their clients not to ‘panic’. In their world, to sell stocks as a means of avoiding risk is to panic. They also confuse volatility with trend. The trend of the stock market refers to the overall direction of stock prices over time. Volatility refers to size of price change over time; both trend and volatility can be up or down.
Investors worry about trend, not volatility. Investors want to own lots of stocks when the trend is up, and not when the trend is down. Investors are concerned about losing money in a down trend. Mutual funds sales people are in the same predicament regarding the income they receive from the management fee their customers pay. When the market drops in half, their income drops in half too. A long term down trend in the stock market is everyone’s financial enemy. Both investors and their advisors should take defensive action now. It’s time to reduce exposure to the stock market.
Let’s examine the financial trends that affect the long term ‘financial well-being’ of most Canadian investors and mutual fund sales professionals.
Trends affecting Canadian investors
The US stock market’s nominal top occurred on Friday Sept. 21, 2018, when the S&P500 touched its all time high of 2,941. The orthodox high was Friday Jan. 26, 2018, with the S&P500 at 2,872. The orthodox high refers to the time when most stocks and industry groups hit their highs. Months later, overall averages rose to new highs based on an exciting market for high tech stocks. Since the high tech bubble burst, the darling tech stocks have been hammered! Apple, the world’s largest company is down 24 per cent from its high. (I wonder if its market capitalization is still the largest in the world.) Amazon is down 25 per cent. Twitter is down 33 per cent. Facebook is down 39 per cent. The game is over. The US stock market is in a long-term down trend.
The Canadian stock market is also in a long-term down trend. The orthodox high occurred in Dec. 2017 with the TSX Composite index at 16,421. The nominal high was 15,586 on Friday July 13, 2018. Let’s review the sub-indices to find the underlying weaknesses and strengths. This list of TSX sub-indices shows whether or not the sub-index is below its own Feb. 2018 low.
1. Health Care Above Strong industry
2. Financials Below Weak industry
3. Consumer Discretionary Below Weak industry
4. Global Mining Below Weak
5. Industrials Above Strong
6. Utilities Same Neutral
7. REITs Above Strong
8. Telecom Above Strong
9. Consumer Staples Above Strong
10. Materials Below Weak
11. Info Tech Same Neutral
12. Gold Same Neutral
13. Energy Below Weak
14. Real Estate Above Strong
Trader’s Note: Gold stocks were weak earlier in 2018, and have rebounded, even though the overall market is collapsing. American Barrick, the institutional favourite of the gold mining stocks, has been particularly strong these past few weeks.
Interest rates are in a long-term up trend
US long term interest rates as measured by long term treasury bond yields are in a long term up trend. This up trend has been confirmed by the trend of short term US interest rates and by the policy statements of the US Federal Reserve Board. The story behind these statistics comes from the US-Chinese trade war. America has instituted tariffs and the Chinese have countered by issuing USD denominated bonds putting upward pressure on US interest rates.
Canadian interest rates are in lock step with American rates. The trend is up. The story in Canada is about mortgage rates and their effect on Canada’s real estate market. House prices are the balloon and mortgage rates are the pin. If interest rates go too high, Canada will have its own Big Bang.
US Dollar vs the basket of non-US currencies is neutral on the long term, slightly up on the short term.
CDN Dollar vs US. Statistically, the loonie has been in a weak up trend since the end of the oil price collapse (Winter 2016). But for 14 months now, it has been drifting lower. The long-term trend is slightly up, short term is slightly down.
Gold is in a sideways drift
Gold is in a trendless sideways drift. We could argue that the long term down trend that began in Sept. 2011 is still intact. (We can demonstrate this statistically using linear regression.) We can also show that the up trend from Dec. 2015 is still intact, although it is quite weak now. If the current trade wars create currency wars, gold will break out of this neutral drift and go up. Don’t worry; we will not miss out if this occurs! But, it is not occurring. Gold is going nowhere for now.
Traders, please notice how strong the gold stocks are relative to the overall market averages. We suspect that this short term relative strength is coming from portfolio managers who remember how gold stocks went up even as the overall stock market began to decline in 2008. As they rid themselves of yesterday’s high tech darlings, they are adding to their holdings of American Barrick.
Energy prices are in a long-term up trend. The current short-term down trend of crude oil is starting to attract a lot of bearish press. This is what happens near trend bottoms. Expect a short term down-to-up reversal. If that does not occur, we will re-examine our premise that energy prices are in a long term up trend.
If you are ‘concerned’, it’s time to sell
Now that we’ve looked over the markets, let’s return to our self-examination. Right now, do you feel complacent about your stock market investments, or concerned?
I wonder what Canada’s most competent portfolio managers feel. I believe they are concerned. Their problem is liquidity. They are so big that their selling depresses the market. They continue to present an optimistic view in order to attract buyers to the market, so they can sell to those buyers. (In my stock market book, Beyond the Bull, I explain in detail how stock distribution works.)
Small investors don’t have liquidity problems. Even with a few million dollars in stocks, you can sell without disturbing the market in the least. If you are concerned, sell now.
Ken Norquay, CMT, is the author of the book Beyond the Bull which discusses the impact of your personality on your long-term investments: behavioural finance. You can reach him at firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the December 2018/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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