Stocktake: Looking for investor capitulation

A stampede out of stocks can indicate the kind of panic associated with market bottoms

Looking for investor capitulation Market sentiment may be awful but investors are not yet "max bearish", indicating any bounces should be sold.

That line may sound familiar to StockTake readers – we used it three weeks ago, but it remains true today.

Yes, sentiment has darkened; indices everywhere are tanking, with bank stocks – especially European banks – bearing the brunt of the selling. In the US, bullish sentiment among ordinary investors has fallen to below 20 per cent, according to the latest American Association of Individual Investors poll, something that has occurred on just eight occasions since 1990. Furthermore, the bull:bear spread is at rarely seen levels.

Sentiment among investment newsletter writers, as measured by Investors Intelligence polls, is also extremely bearish.


That may sound like true panic, but the Vix, or fear index, suggests otherwise. It remained below 30 last week, well shy of panic levels seen during past market crises. Europe's equivalent, the VStoxx, is higher, but it too is well below levels recorded during last August's steep but short downturn.

A stampede out of stocks can indicate the kind of panic associated with market bottoms. 2016's selling may seem unremitting but there has been little sign of investor capitulation. Until that changes, traders are likely to continue selling the rips rather than buying the dips. Buying into global bear markets Investors, of course, play by different traders. A market bottom may be elusive, but should you be putting cash to work?

Short answer: yes. Although the S&P 500’s peak-to-trough decline has thus far been relatively modest, indices around the globe are firmly in bear market territory.

Investment strategist and blogger Ben Carlson last week noted that the MSCI World Index has suffered 10 bear markets (declines of at least 20 per cent) over the last 45 years. What if you bought when stocks had fallen 20 per cent?

Lower prices almost invariably followed; on average, Carlson found, stocks fell by 28 per cent, with three declines exceeding 40 per cent.

One year later, however, stocks were higher on all but two occasions, gaining an average of 20 per cent. Three years later, stocks were higher in nine of 10 cases, gaining an average of 39 per cent. Within five years, stocks were higher each time, gaining an average of 81 per cent.

Things may seem scary at the moment, and they may get a lot scarier. Still, stocks actually become less risky when they fall in value, as the above figures show. “Long-term savers and investors should see this as an opportunity, not a crisis”, says Carlson. “Global stocks are on sale.”

The perils of cash Two years of market gains have been quickly wiped out, with US indices now below levels seen at the end of 2013. While holding stocks can be stressful, sitting in cash brings its own pressures too, namely: when do you get back into the market?

Despite the recent hammering, Bespoke Investment Group noted last week, the average S&P 500 stock is still up by 330 per cent since the market lows in March 2009. However, the average stock is up just 105 per cent since the end of 2009. In other words, even if you were invested for the vast majority of the long bull market, you would have missed out on the bulk of the gains.

Many investors, spooked by the severity of market losses in 2008 and early 2009, would no doubt have waited much longer again to get back into stocks. Others may have missed the bull market entirely.

So yes, stocks can be stressful, but don't overestimate the pleasures of cash. Schiff is more wrong than right You'll find many smart, objective data-driven strategists in the bearish camp. You'll also find Peter Schiff.

Schiff, a gold-loving libertarian who has long been preaching that the world is going to hell in a handbasket, was in fine mood last week. “It’s good to finally be making money,” he told Marketwatch. “People just don’t want to give me credibility by acknowledging that I had it right, because it means that they have to acknowledge that they had it wrong”.

For years, Schiff has been predicting a market crash. He’s also been saying that gold would hit $5,000 as well as warning of hyperinflation and a dollar collapse that would send consumer prices, interest rates and unemployment “absolutely ballistic”.

How this qualifies as being “right” is beyond me.