Friday, December 5, 2008

A Hundred Years of Bear Markets --- I


It's a recession when your neighbour loses his job; it's a depression when you lose yours.
Harry S. Truman

The bear market of 2007 is unprecedented in the modern times. At the onset of the bear market in late 2007, a few savvy market observers started to contemplate whether the bear market of 2007 was going to be a replay of 1973-1974 or 1981-1982. Well, their bets are off :-). With the greatest predicting power of the stock market, the vicious decline and the historical volatility in the last two months foretell we are going to witness the worst ever bear market since the great depression of 1929.

Over a short span of 10 years, our generation has tasted twice the bitter fruits of bubble economies, the burst of the internet bubble in 2000 and the collapse of the housing bubble coupled with credit market bubble and commodity bubble as of today. How many had thought that they would never see another 2000 alike bubble again in their lifetime a few years ago? Well 8 years later, a once in a hundred years event happens again, though in a slightly twisted form but with even more destructive consequences.

Bear market is a great time to reflect ...

Bear market is a great time to relax and reflect. It is a period where great efforts should be devoted not to trading, but to thinking. You should protect your capital, save your ammunition to wait patiently for the next brand new bull market with clear understanding that the easiest (with minimum risk) and the biggest money are made in bull not in bear. This is the drive behind my embarking on the road to study the history of the bear markets in the last hundred years.

In the next series of articles, we will study the major bear markets in the past, the top which led to the collapse of the stock market, the bottom which proceeded the emerging brand new bull and the false bear market rally(ies) which sucked in all the premature bottom callers in between ... We will return to this topic next week.




Current US Market:

The fact that market rallied in face of the ugly employment data last Friday is encouraging. Have we priced in all the bad news? Will the approval of some type of loan to the big three auto makers from Congress this week provide the catalyst to the much waited year end bear market rally? (or the rejection of the loan to derail the rally?). Let's wait and see.



Chinese Market:

The picture in China looks much better than US. I think the strong bear market rally has started. Here is the picture of FXI. Chinese market could rally all the way to 200MA of major indexes.

I am going to put some money to work on FXI with stop loss around 25.



Other Stocks
  • Continue to hold AXYS taken last Wednesday.

Wednesday, December 3, 2008

let's poke a little -- AXYS

I am going to buy a little of AXYS tomorrow at market open. Small position.

Thursday, November 27, 2008

Proactive Asset Management -- Yes, You Can Time the Market

The bear market of 2008 will surely be written to the history book as one of the most brutal ever in the stock market history. As of 11.21.2008, SPX500 plummeted 49% from its all time high of 1576 made in the Oct of 2007. In the same period of time, DOW lost 43%; Nasdaq Composite lost 51%. The record point losses, the vicious circle of deleveraging, asset collapsing and the melting down of the global financial system are simply stunning to watch. Treasury Secretary Henry Paulson called the current financial tsunami a "once or twice" event in a 100 years. Have we seen the worst of the crisis yet? I think we have a long way to go. What is good about this bear market is that once this bear market is over, the next bull market will be equally powerful to provide fantastic opportunities to profit from. It could be your life changing event if you know how to profit from it. The question you should ask yourself now is Are You Prepared?

With market in panic mode, what is equally stunning (and amusing) is that, nearly all major financial news networks, radio stations, newspapers, financial advisory agencies are calling investors to stay calm, stay fully invested. The argument they use is simple, YOU CAN'T TIME THE MARKET. This leads to today's topic: Proactive Management.

Since the premise has already been set that You Can't Time the Market, if you ever do, you will end up badly with miserable returns. In today's media, what I hear the most from commentators is the following quote,

In the ten year period ended December 31, 2007, if you remain fully invested, S&P500 average annual return is 5.91%; However, if you missed the 10 best days, S&P500 average annual return reduces to 1.13%.

Let's dissect the above statement. The statement has some legitimate points. I can imagine a vivid picture how typical investors missed the best days in the market.

It is a well known fact that the biggest up days all happened in bear markets. Let's look at the 10 biggest up days of SPX500 from 1950 up to today Nov 27, 2008.


10/13/2008

11.58%

10/28/2008

10.79%

10/21/1987

9.10%

11/13/2008

6.92%

11/24/2008

6.47%

11/21/2008

6.32%

7/24/2002

5.73%

7/29/2002

5.41%

10/20/1987

5.33%

9/30/2008

5.27%


SPX500 10 biggest up days from 1950 to 11.27.2008

Among the 10 biggest up days in the past 60 years, six of them are from 2008 alone. This is simply shocking! Two of them happened in 2002 when the collapse of the Internet Bubbles was still rippling through the economy. The two remaining ones happened right after the black Monday of Oct 19, 1987, the biggest one day stock market crash in history with SPX500 lost a whooping 20%.

Why the biggest up days all happened in bear market? It is simple. In bull market, you see calm orderly advance. Big institutions are at work to nimble up shares. In bear market, emotions are running high. The doom and gloom are broadcasted daily in the news. The greed and fear of human nature are at the full force. (The other times you see greed and fear in display is at the market tops). The market is characterized by choppy, volatile motions.

Here is how a typical investor Joe missed the 10 best days in bear market. When the bear was the ugliest, Joe got scared. "What if the market goes down another couple hundred points? All the news media talking heads are pessimistic about the economy!" Joe decided to pull his money out (e.g. 401k). Then within a few days, market went up 10% in a day. Joe became scared again. "This must be the bottom". He put his money back to the market. This is a classic action from a typical Wall Street participants.

The study of missing the 10 best days, which dramatically reduces your long term return, is legitimate. It shows how a typical investor, if becomes "proactive" in bear market, can end up miserably in his own financial well being.

The other side of the study shocks me too if you read the numbers. In 10 years period of time, if you remain fully invested, SPX500's annual return is ONLY 5.91%. (Majority of the mutual funds can't beat the market, the return of SPX500 is a good proximity of the long term returns).

I went ahead to look at the 30 year return which is representative for a working class for his retirement account. Here are the results,

The year in which 30 year period is ended

30 year annual return

2008

7.28%

2007

9.31%

2006

8.69%

2005

8.88%

2004

9.83%

2003

8.12%

2002

6.41%

2001

8.06%

2000

9.02%

1999

9.44%

1998

8.27%

1997

7.62%

1996

7.27%

1995

5.95%

1994

5.08%

1993

5.66%

1992

6.10%

1991

5.39%

1990

5.28%

1989

5.44%

1988

4.76%

1987

5.64%

1986

4.89%

1985

4.41%

1984

4.41%

1983

5.94%

1982

4.98%

1981

4.86%

1980

5.94%



The average 30 year annual return from 1950 to 2008 is 6.65%, which is not far from 5.91%. There is a tendency that market accelerates to the upside. The 30 year annual return is clearly growing to the upside from average 5% in the 80s to average 6.6% in the 90s to average 8.4% from 2000 onwards.

The returns from the above table is far from 12 - 15%, which is what I have been told over the years by buying and holding mutual funds in 401K.

Is the market really NOT timable? The Wall Street common wisdom says NO. Majority, if not all, talking heads on TV say NO. Nearly all financial advisers say No. You can not time the market, NO ONE can time the market. The wisdom is so overwhelming that any school of thoughts which deviates from it is considered a cult of the market.

Wall Street is a sell side. Stock brokers or financial advisers are not in the business to provide you timely advice because their job is really all about asset gathering. They love to tell you when/what to buy, but they nearly never tell you when/what to sell. They need to keep you invested so that commissions can continually be generated from your investment/portfolio.

Proactive Asset Management is not Buy and Hold. Proactive Asset Management thinks market can be timed.

Proactive Management is not hyperactive trading, in which investors engage in excessive short term tradings.

To me, Proactive Asset Management is about liquidating significant percentage of risky assets or moving the risky assets to safe assets at the onset of the bear markets and do the reverse at the onset of the bull markets.

Market can be timed. Proactive Asset Management can drastically improve your returns.

The most reliable way to identify the market tops is by looking at the actions of leading growth stocks and major indexes. If leading growth stocks, after long advance, one by one, sector by sector start to experience heavy institution selling and their technicals start to break the intermediate and long term moving averages; At the same time, major indexes show heavy volume churning and choppy actions and their long term moving averages (e.g. 200MA) start to flatten out and roll over, this is the most reliable sign that a bear market is about to start. This is the time you should be on high alert and aggressively raise cash.

In today's blog, we examine a simple yet effective way to identify market tops and bottoms. We exam its effectiveness over the span of 30 years.

What we are going to look at is the EMA13 and EMA34 cross over on weekly charts of SPX500. John Murphy has several articles on this topic in his market messages.

The chart of SPX 500 from 1999 to now.


The chart of SPX 500 from 1996 to 2000.


The chart of SPX 500 from 1990 to 1995.


The chart of SPX 500 from 1986 to 1989.


The chart of SPX 500 from 1981 to 1985.


What are your conclusions after you study the charts on the effectiveness of EMA13 and EMA34 on weekly charts (in short, EMA13/34 crossover)?

Here is mine,

  1. EMA13/34 crossover lags the onset of bear/bull markets. If you use it alone, you can be too late to sell in bear and too late to buy in bull (e.g. 1987 market crash, the crossover happened after the crash)
  2. EMA13/34, although lags the onset of bull/bear, it is a great way to confirm the bull/bear markets. There is never a miss in the span of 30 yrs.
  3. The longer the previous bull, the longer the bear, the more effective is the crossover. (e.g. 1981, 2000 and 2008 bear markets)
  4. The shorter the bear, the faster the drop, the less effective is the crossover (e.g. 1998 bear market)
  5. When the market is in trading range, the crossover gives false signal (e.g. 1994).

In summary, the EMA13/34 crossover is a great reliable indicator to use to identify the bull/bear markets, but it can NOT be used alone.


Current Market Comments:
  • This is bear market rally. How long, how far will it go, I have no idea and I have no interest to know beforehand. Remember I don't make predictions and I don't trade based on what I (or other people) think market will happen next.


Current Portfolio:
  • Trading Acct: 95% cash.
  • 401k Acct: 100% money market.


Thursday, November 13, 2008

A Key Reversal Day?

There is no doubt today is a bullish day. In technical chart analysis, today is a positive Key Reversal Day. I was trying to google the text book definition of the Key Reversal Day, but with no luck. Technicians seem to differ on several details of the definition.

The following chart from incrediblecharts shows intuitively what a Key Reversal Day looks like.


Regardless if today is a classic Key Reversal Day, this is what happened with SPX 500 today.

  • Market went down 7 days in a row (well, with one up day in the middle) with SPX 500 registering a 15% loss before today.
  • The index broke new low. In fact, SPX broke the intraday low of Oct 10th.
  • The index closed higher than the intraday high of yesterday.
  • The index closed at the high of the day.
  • The volume went significantly higher.

Key Reversal Day carries a bullish implication, at least in short term basis. There is no guarantee that a Key Reversal Days will kick off a strong bull run. The rareness of the event combined with the context of the market indicate today could be the start of an intermediate bear market rally.

My previous post suggested a range bounded market until the early December to form the bases of a tradable bear market rally. I still hold that view. I am just a little surprised the re-test of the Oct low happened sooner than I thought.

In the next few days, we need to see constructive signs with market rising on higher volume and backing off on lower volume.

The next few charts supports the bullishness of the case.




VIX backs off from the trendline.



Jap Yen drops again and showing positive divergence.

In the charting landscape, things are looking much better than October. Leadership has expanded from medical to education, retail-discount, regional airlines, food, small banks (Well, can these industries be the real bull market leaders?????). If market can go side ways and more accumulations enter the market, the year end bear market rally is in the card.

The following picture is what I like market to do in the next few days ... Am I making predictions? Yes. Do I trade based on my predictions? NO. I trade on what I see/saw, I do not trade on what I think market will happen. I want the year end bear market rally BADLY (to make some money), that's all ... lol



Today, I do have a good long I am going to take. By the way, ENB short was closed today before market close with a little gain, I will reenter short once the bear market rally is over.

Going long tomorrow at market open: DLTR




Keep the position small, we still need to wait for the follow through day to confirm the rally.




Wednesday, November 12, 2008

Short ENB

A good short candidate for tomorrow's market: ENB.



High volume sell off then low volume rally back to 50MA. Final cut loss @ 50MA if the stock closes above 50MA.

Sunday, November 9, 2008

Market likely to be range bounded before a "powerful?" tradable rally in the year end

The market is in bear market. The economy is in recession if not depression. The primary trend is down.

Everyone is looking for a year end rally. The question when we will get one is in everyone's mind. Bear market rally comes from all forms, some of the strong ones can produce powerful returns.



There are several positive factors in the making,
  • The market is still quite oversold in the intermediate terms.
  • New lows are not expanding, a positive divergence.
  • Market enters the favorable seasonal period from Nov to May.
  • The Banking Index is holding the low made in July and showing the relative strength to the market
There are some disturbing factors as well, two outstanding ones,
  • There is no market leadership, other than a few medical stocks, it is a waste land.
  • The 50MA is still quite far from the index indicating more sideway work needs to be done.
One recent bear market rally we can compare to is March of 2008. Compare to today, can you tell the difference?

I still believe the market will have a tradable rally before the year end, but for now. I think market will range bounded to early December of 2008.

For growth investors, your strategy continues to be sitting with large percentage of cash.

Saturday, November 8, 2008

The Project of Wealth Realization

The Myth

Wall Street is a myth. On the surface, the daily fluctuation of the stock prices creates endless opportunities to profit from. Once you dip your toe into the market, you start to realize Wall Street is such a merciless beast that squeezing some profits out of it represents a daunting task. Among all investors, only a tiny percentage makes money consistently over the long run.

In the May 2004 paper entitled "Do Individual day traders make money? Evidence from Taiwan", UC Berkley professor Terrance Odean assesses the success of day traders in the Taiwan stock market using detailed individual trading records, they found that individual investors account for majority of day trading activities and over 80% of day traders lose money after transaction costs.

In a study by Wall Street Journal published in 1987 that between 75% and 95% of all commodity investors lose money. A few savvy traders make good money from the vast majority of less sophisticated players.

It is a fact that mutual funds managed by professional money managers, on average, do not beat indexed funds. In one of the best selling books ever about investing, "A Random Walk Down Wall Street", the author, a Princeton professor hypothesized that "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts." In 1988, The Wall Street Journal, picked up on the popularity and novelty of the idea and ran the experiment of pitting monkeys (blindfolded journalists) against professionals. The rules got changed continuously as experiment upon experiment was run. When the 100th contest ended, the Wall Street Journal presented the results. The professionals won 61 of the 100 contests against the Dart throwers. Though the professionals won, this slim margin was quite embarrassing for these supposed experts. What was worse was that the pro's only beat the Dow Jones Industrial Average in 51 of the 100 experiments. In theory, by just investing in the Dow, you could do just as well as following expert advice.

Nevertheless, Wall Street provides enormous money making opportunities. Selected few savvy investors, money managers, individual investors have amassed enormous wealth over time. What makes them stand out?

What differentiates pros from the amateurs, winner from the losers in Wall Street? Are there common traits exist in all those legendary investors? As an individual investor, is there any system we can leverage to profit from?


The Market

Efficient market theory stops its usefulness at the wall of the ivory tower. Under the theory, there are no trending stocks, market timing is impossible. The market reaches instant equilibrium as soon as the new information is disclosed. The hypothesis maintains that it is impossible to use technical, fundamental or expectational analysis to beat the market.

Efficient market theory only holds if the market participants are perfectly informed, emotionless robots. As was aptly stated by William O'Neil in Jack Schwager's book, Market Wizards, "The stock market is neither efficient nor random. It is not efficient because there are too many poorly conceived opinions; it is not random because strong investor emotions can create trends." It is this inefficiency and trending which create enormous opportunity to profit from.

The most fascinating thing about the stock market is that what works in the stock market is contrary to human nature. Greed and fear take over the consciousness of the majority investors when real money is on the table. Typical investors nearly all sell at the end of the bear market, and buy near the end of the bull market. The interesting phenomena you can observe for years is that when all Joes on the street, all Jacks in the internet discussion board are making money and starting to boast how fast they can make money by buying out-of-money near-term options; how proud they are on their own proprietary trading systems; how smart they are by doubling their dollars by buying the over the counter pink stocks etc. You know the bull market is getting close to the end and all Joes and Jacks are destined to lose all.

The game of Wall Street is more of a psychological than a game of odds and economic know-how. To me, the game is 70% of psychology, 20% of statistics and 10% of economics.


The investors

There is a single Warrent Buffet.

There are couple Peter Lynch(es).

There are couple George Soros(es).

There are couple James Simons(es).

There are couple Ken Heebner(s).

There are couple David Booth(es) who made himself known after donating $300-million gift to the University of Chicago's business school.

There are a massive number of underperforming mutual fund, hedge fund, pension fund money managers, who make their living by managing others' money.

Then we have the sea of small fishes and shrimps, the individual investors, who come to Wall Street with only one purpose, to make money. Over the century of stock market history, a few individual investors, WHO PLAYED THEIR OWN MONEY with lone hands, stood out the market tests with enormous success. The classic examples are Jesse Livermore, Nicholas Darvas, and William O'Neil.

As an individual investor, who should we follow? Or should we invent a system of our own? Well, it is true all road leads to Rome, majority are filled with traps and landmines. There are a few standing out ones which are clearly more superior than the rests.

As an individual investor, what advantage or disadvantage do you have comparing to top notch Wall Street institutions?
  • Small investors have no edge or advantage when it comes to fundamental research.
  • Big institutions and funds will almost always have superior information.
  • Small investors have the advantage of being flexible and quick moving.
  • If a small investor is disciplined, he or she can use charts and superior money management to follow the smart money into the best stocks and generate superior gains.

In light of the common mistakes of typical investors and clear disadvantage of the fundamental research over the big Wall Street money house, we need to adopt a trading system which can clearly put the winning odds in your hands.


The strategy

In the most general sense, trading success requires 3 basic components: an effective trade selection process, risk control, and discipline to adhere to the first two items.

Over the span of a hundred years of stock market history, stock market spends more than twice as much time in bull market as in bear market. Since 1854, an average business cycle lasted 53 months. The average bull market was 35 months and the average bear market was 18 months. Between 1945 and 1991, the average bull market was 50 months and the average bear market was 11 months. In each bull cycle, normally there are several innovative market sectors and industries to lead the market higher. Top companies within the leading industries with superior fundamentals (big EPS and sales growth, superior products) will SIGNIFICANTLY beat the market (e.g. comparing to SP500). In the following bear cycle, market normally corrects with much bigger volatility, some of the former leading stocks get sold hard and forever finish their bull run. Market goes through changes of leadership until next bull market starts. This phenomena can be best seen in the dot-com bubble of 2000.

To leverage this historically repeating pattern, a trading system can be designed to ride each bull phase buying top leading stocks in leading industries to maximize the profits and move to cash heavy in bear market to preserve capital. To play the market cycle by cycle, by compounding, you can amass enormous wealth.

This is what CANSLIM does. CANSLIM is the trade mark of IBD.

In the nutshell, CANSLIM strategy can be summarized in the following:

  • Once market comes out of a bear market, buy top leading stocks (companies with superior earning growth) within top leading industry (the sectors with top relative performance leading the entire market higher), which break out of sound consolidation bases on brisk heavy volume.

  • Hanging on to leading stocks as long as the fundamentals and chart patterns continue in favor of higher price and market remains healthy. Pyramid on the way up.

  • Sell when stocks enter classic topping patterns, e.g. climax run, or high volume breach of important moving averages, or showing signs of heavy institution distributions.


  • During bear markets, keep heavy in cash.

I use CANSLIM system with some added momentum strategy of my own.

Once you have a winning system, as if you know you are the casino owner, not a gambler by playing it again and again, the rest of game requires your discipline and consciousness of the mind. You need to sell into strength when you see euphoria of averages Joes in discussion room; You need to refrain from buying and sit with your capital when market offers you no opportunities; You need to act decisively and pounce once the opportunity is upon you; You need to cold bloodly sell your losers and patiently wait your winners to perform.

The flair

"NOTHING IS MORE DIFFICULT, I truly believe, than consistently and fairly profiting in Wall Street." said Gerald Loeb in his first chapter of the book "The Battle of Investment Survival".

He continued, "Knowledge born from actual experience is the answer to why one profits; lack of it is the reason one loses. Knowledge means informaiton and the ability to interpret it marketwise. But, in addition, making money in the market demands a lot of "genius" or "flair". No amount of study or practice make one successful in the handling of capital if one really is not cut out for it."

The end

The purpose of the blog is two fold: It creates a place holder to collectively store my thoughts, observations and studies of the market. Secondly, this is my second Ph.D. thesis. If my first Ph.D. thesis led me to understand the science and engineering, the second will lead me to understand sociology, economics and best of all, human nature.