Volatility in the stock markets since the beginning of the year has made analysts and investors alike clutch their stomachs. Is this a crazy market or a sane one? Is it a bull market or a bear market? Is it topping or bottoming?
We've been clear on this topic: It's a bear-market rally waiting to resume the larger trend lower.
But the craziness in the financial markets due to the credit crunch has got individual stocks popping up and down, particularly of those companies that provide financial services. Take General Electric, for example. It announced this week that its profits were far less than forecast. Its stock then dropped like a stone (more than 12%), GE’s largest decline since the 1987 stock crash and a loss of more than $42 billion in market capitalization. Here's how Bloomberg reported ensuing events:
On a conference call today, analysts demanded that [CEO Jeffrey] Immelt explain why he told retail investors on a March 13 Webcast that Fairfield, Connecticut-based GE would likely meet its annual forecast of at least $2.42 a share.
``Two days after the Webcast, the Bear Stearns situation took place,'' Immelt said. ``The last two weeks in March were a different world in financial services." (Bloomberg, 4/11/08)
It's that kind of "different world" that can unnerve the CEO of a multinational company such as GE, not to mention individual investors in financial markets. But this kind of craziness has happened before, and here's how Bob Prechter responded to a reporter's questions on the topic of market crashes in this question-and-answer excerpt from Prechter's Perspective
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Excerpted from Prechter's Perspective, re-issued 2004
Q.: When people fail to become "professional" in their approach to the markets, they frequently exit the way frustrated gamblers leave Las Vegas: absolutely convinced that the deck is stacked in favor of the house. Usually, there is a feeling that the game used to be fair, but it somehow became rigged against them. Is this accurate?
Bob Prechter: Yes and no. The game is not rigged, but it is stacked against them, because their opponent is their own unconscious emotional mind. Can your cerebral cortex beat your very determined unconscious mind?
Q.: But you have to have some sympathy. Looking back on paper, October 1987 is just a line on a chart, but as they lived through the crash, many found it very hard to understand how values could legitimately go from where they were on August 25, 2987, to where they were on the morning of October 20.
Bob Prechter: Well, of course, I sympathize, both with the pain and the lack of understanding. All I am saying is that the latter must be fixed before you'll have a chance of avoiding the former.
Q. How?
Bob Prechter: Most investors believe that they are dealing with a law of cause-and-effect with the market's action on the "effect" side of the equation. The market does operate in a cause and effect world but is a reading of what is on the "cause" side. The market's behavior itself just IS. It is a manifestation of naturally rhythmic mass mood change. Any student of the market, as opposed to a theorizing model-builder, will have to come that that conclusion. George Lindsay, in his very last market letter, published in 1985, said this: "Is it a 'crazy' market? Most professional market men call this a 'crazy,' 'outlandish,' or 'weird' market. I can see nothing about it that differs materially from other strong advances…." That is from a man who wrote market commentary for 34 years and saw all types of markets. A fox only appears to be crazy if you expect it to behave like a chicken. Similarly, the market only appears to be "crazy" if you expect it to behave according to the laws of physics rather than those of sociology, upon which it is actually built.
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Q.: So conspiracy theories are an easy scapegoat.
Bob Prechter: Conspiracy theories have an appeal, not only because the money loser can rationalize his failures, but also because it keeps him from having to admit he's too lazy to do the exhaustive work required to figure out how to make money at trading. They are a substitute for taking responsibility.
Q.: You've said that such theories do have one merit. When an analyst finds that one such theory is believed by most people, he or she can be sure that they are close to a market turn, usually a bottom. What are some other characteristics of a major market bottom?
Bob Prechter: General despair. Investors completely give up. Sometimes you even begin to hear arguments as to why that market really has no reason to exist. For instance, in 1932, people said capitalism was dead, stocks were dead, and they'd never go up again. We had that situation in gold in 1971, when the government decontrolled it. Several economists came out and said that as soon as they took off the price controls at $35 an ounce, gold would drop to $6 an ounce because it had no industrial utility.
Q.: The market is an amazing beast. It even manages to do damage on the way up. Richard Russell has said that the "diabolical objective of bull markets is to advance as far as possible without any people getting in." The opposite is apparently true in bear markets.
Bob Prechter: Exactly. It's the old story. Bull markets climb a Wall of Worry. I made up a parallel maxim: bear markets slide down a Slope of Hope.
Q.: In the mid-1980s, you anticipated this idea in the great bull market when it was just getting under way. You said, "Somehow the Dow has to get to 3600-plus with almost nobody aboard.
Bob Prechter: All I really meant was that for the mechanism of the market to be satisfied, there must be reasons for people to disregard really important advice at the time it is most important that they actually take it. The psychology of 1984-85 was exquisitely instructive in this regard. Advisors, newspapers and brokers hated the markets. They were amazingly bearish. So the market went up with the fewest possible people participating. In fact, they were shorting and losing money as it rose. The history of markets shows that over 90% of investors cannot make money in the market. The few successful ones you occasionally hear about usually took the approach of long-term buy-and-hold, without regard to trend, and they were lucky enough to be in a multi-year bull market….
Q.: Let's say you could dissect the average investor's stock portfolio over the course of a full cycle. What would it reveal?
Bob Prechter: More than 75 years ago, Don Guyon, the pseudonymous author of One Way Pockets, wanted to discover why his clients always lost money in a complete bull-bear cycle. It might be argued, he reasoned, that, at worst, they should have broken even, since at the end, prices were back to where they were at the start. He found that the answer lay in the clients' temporal orientation to the market's future. At the beginning of a bull market, he found all his clients were traders. At the top, they were all "investors." This is not only precisely the opposite of the correct orientation for making money, but also entirely natural for human beings and a key reason why the market repeatedly behaves as it does.
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Q.: When will we know for certain that we have seen a market top?
Bob Prechter: For certain? When it's too late to act!
Q.: If you don't know until it's too late, should traders try to pick tops?
Bob Prechter: By all means, yes. Waiting for certainty means waiting long enough to miss it.
Q.: At what point in the Dow would a crash scenario become a possibility?
Bob Prechter: Any time it's open.