Thursday, November 15, 2012

"With a market in freefall, they can't possibly have the confidence to hold or buy at severely reduced prices." --Howard Marks

WHEN EVERYONE IS ASKING HOW LOW WE'RE GOING, BE A BUYER (November 15, 2012): If you read any financial web site, or turn on any financial cable TV channel, you'll discover some variation of "how much lower is the market going to go?" or "how long will this correction last?" Nearly all important buying opportunities exist when practically everyone is worried about how much more money they're going to lose, rather than what compelling bargains are available. Exactly four years ago, in November 2008, investors had precisely the same concerns. Those who were bold enough to act rather than pout, especially if they purchased cyclical shares such as semiconductors or the shares of commodity producers, were handsomely rewarded as they doubled or tripled by early January 2010. While valuations are not as depressed today as they were after the first election of President Obama, most cyclical shares in materials, energy, and mining industries are close to their lows from July 2009. They are thereby providing the opportunity for gains averaging 25%-35% within a half year. While everyone else is worried about how much lower they're going in the short run, it's far more important to consider how much they would have to gain to merely return to their highs from February-March 2012.

The financial markets are always an anticipating mechanism. When everyone was expecting Facebook to have a successful IPO, its price peaked on the first day and plummeted thereafter. On November 14, when the lockup period ended, everyone figured that Facebook would collapse from the onslaught of new shares for sale, and instead it surged higher. Everyone is worried about the implications of the fiscal cliff, which means that many have sold in expectation of additional future losses. Even if a final resolution is weeks or months away, the eventual anticipation of a deal will soon begin to lift equities higher--and they have plenty of rebounding to do because they have become so oversold in recent weeks.

On November 14, the S&P 500 broke below its 200-day simple moving average. This likely encouraged many investors to sell in anticipation of an alleged downside breakout. If you look back to earlier in the year, the exact same behavior occurred at the beginning of June when the S&P 500 similarly dropped below its 200-day moving average. Many sold in panic when they should have been buying at the lowest prices of the year. A similar panic in early October 2011, which many analysts thought was the herald of a new bear market, proved to be yet another essential buying opportunity. The greater the number of people who think the sky is falling, the more who have already sold out of fear of future losses, leaving few remaining who could become motivated to sell.

If the financial markets were really on the verge of Armageddon, then we'd have the U.S. dollar index soaring, U.S. Treasuries surging higher, and the fear gauge VIX hitting new highs for the year. Instead, we have all three of the above struggling to surpass their highs from the past week, while remaining well below their July 2012 peak levels. Perhaps even more importantly, there has been a surge of insider buying in recent trading days by top executives who recognize how dramatic these bargains have become, while insider selling has diminished so that the ratio of buying to selling has soared to a level which is far above average. This insider buying is occurring heavily for cyclical equities and financial companies, while the selling has remained concentrated mostly in defensive high-dividend shares which had become dangerously overvalued by being so widely recommended by too many financial advisors chasing after yield.

The fewer the number of people you know who are eager to buy stocks, the more aggressively you should buy. Several months from now, when very few will want to sell, you'll know it's time to do precisely that.

Disclosure: Since May 2012 I have been progressively accumulating long positions in funds of commodity producers into pullbacks and especially whenever they are forming higher lows. From my largest to my smallest position, I own GDXJ, VFWPX, KOL, XME, EWZ, REMX, SLX, VEMPX, VINIX, RERGX, RSX, VGPMX, TNRPX, TRIEX, FCG, TAN, GDX, ACTIX, TRSPX, and NLR.