Market Performance After Big Crashes

Some of you have probably heard the saying “Bear markets make people a lot of money, they just don’t know it at the time”. This morning, Meb Faber is out with some interesting observations that confirm the same notion. What is the 3-year return of different asset classes after they have crashed:

Average 3 year nominal returns when buying a sector down since 1920s:

down 60% = 57% recovery

down 70% = 87% recovery

down 80% = 172% recovery

down 90% = 240% recovery

Should this data encourage you to hold forever to your losers and remain fully invested in any market environment? No, let’s take a quick look why:

If an asset drops 90%, let’s say from $100 to $10; then a 240% gain will bring it back to $34, which is still 66% below the starting price. Not a big consolation, right?

We all know that momentum works best in a 3 to 18 months time frame and anything beyond 3 years, usually leads to mean-reversion. Sooner or later all uptrends and downtrends end. Some downtrends end with bankruptcy.

Any asset that is down 90% is probably priced for bankruptcy in some way or another. Of course, if the perceptions turn out to be much worse than the reality and that asset survives, it will rally big time and be among the best performers during the recovery process. We all saw the massive 1000%+ returns from the 2009 bottom in some of the cyclical stocks – truckers and furniture stores. Buying a basket of small cap stocks after big market crashes has worked flawlessly in the U.S. over time.

The big question is – do you buy blindly, any time an asset is down 80%? What if it gets to a point being down 90% from its original price? A move to being down 90% after being down 80% is a another 50% loss. (From $100 to $20 to $10). There have been numerous bottom hunters in the coal industry over the past couple years, only to find out that there is a hole in the bottom later. What if an asset that is down 90% gets to a point where it is down 99%. It happened in Cyprus.

To take advantage of such massive crashes, you have to keep your powder dry. You need to protect your capital in signs of weakness and actually cut your losers when their trends get broken.

There is a way to use market crashes to your advantage, but it is not by buying blindly anything that is down 80%. I will talk about it in another post.


Silver Linings and Discounting Identified Risks

Last week started with fireworks and ended in flames. High volatility after a prolonged uptrend is a sign of distribution. Ever since the major reversal on May 22nd, market indexes have been in a distribution mode – choppy, range-bound environment, characterized with a large number of fake breakouts and breakdowns and where most trends last 2-3 days before there is price reaction.

An hour before the FED’s briefing on Wednesday, everything looked rosy and the S & P 500 was within a striking distance from testing its all-time highs. The St50 list was up 3.5%, four of its stocks were up more than 10% in a couple days, another ten stocks were up 4%+. Then Bernanke came and said that the economy is improving and tapering of the FED’s open market operations is within sight. The market reacted like child, whose birthday party has been canceled and staged a massive selloff. The St50 list finished the week down 1.55% and while it outperformed the $SPY and $QQQ, the technical damage to many of the leading stocks was notable and it will take some time to be repaired.

Financial markets have been discounting FED’s withdrawal since the end of May. Look at the massive rally in the yields and the epic selloff in the most interest rates sensitive assets. The 10-year yield has gone from 1.6% to 2.5% in six weeks. The REITs ETF ($IYR) is now down for the year after being up 20% by mid May. Emerging markets ($EEM) and long-term Treasuries ($TLT) hit new 52-week lows.

The silver lining of last week is that at least now we have some certainty in regards to FED’s plans and targets. Identified risks tend to be over-discounted by the market. While we might get a few more weeks of elevated volatility and forced liquidations, a good earnings season could get us back in everyone’s favorite “market of stocks” environment. Next earnings season starts in mid July.

The big question for the next few weeks is if the accelerated distribution and elevated volatility will turn into forced liquidation and clear downtrend. After a few big down days, the mood is always gloomy and it is easy to be pessimistic. The market in June has proven to surprise and mean-revert just when most have positioned themselves in one direction, so I think we will see more of the same.

New leaders always emerge out of market corrections and they are likely to appear on the St50 list before the meat of their moves. It is always worth it to pay attention to relative strength in weak markets.

Regional banks ($KRE) held their ground better than most last week. We even saw a few breakouts to new all-time highs ($SBNY). The steeping of the yield curve is positive for the group.

Last week, we talked about the major re-pricing in media stocks. Many of them showed incredible resilience during the pullback and are hovering near multi-year highs: $SBGI $NXST among others. It is a group that deserves special attention.

Also, contrary to the popular perception that defense stocks should take a massive hit from the sequestration, many of them have managed to have a very decent 2013 and are holding near all-time highs: $IRBT $TDG $GY.

There is a strong underlying bid for small and mid cap software and cloud stocks too: $WAGE $TYPE $ULTI $CSOD $EPAM $VNTV…

It Is A Very Choppy Environment, But Opportunities Abound For Nimble Traders

The S & P 500 lost 1%, Nasdaq 100 lost 1.5%, small caps shed 0.5% and yet overall there were more stocks that went up 10% for the week (54) than went down 10% for the week (42). It continues to be a market of stocks environment with good opportunities for both bulls and bears, who know how to manage risk. The ST50 list finished the week flat (gained 3 basis points) outperforming the indexes by a good margin.

$SPY tested its rising 50dma for a second time in two weeks. Technicians say that the more one level is tested, the weaker it becomes and the more likely to be taken out. A break below the 50dma is not the end of the world. Many trends test their longer-term moving averages before they resume higher – 100dma, 200dma and even the 50-week MA.


It is a very choppy environment, but opportunities abound for nimble traders who have managed to adjust to the range-bound market environment. Most of the trends last up to 2-3 days before there is a major price reaction. We need to start every day with an open mind and be prepared to see everything.

Three industries stood above the rest last week:
– restaurants: tepid inflation coupled with rising consumer confidence and pure price momentum send stocks $CHUY, $SONC and $RUTH at new multi-year highs. There are a lot more names in the group that are hovering near 52-week highs: $CMG, $TXRH, etc.
– media: the ongoing consolidation in the field is re-pricing the whole TV broadcasting industry. Many of the stocks in the group gained more than 5% last week: $SBGI, $NXST, $SSP, $TVL, etc.
– mortgage investment companies were among the best performers in 2012 and it looks like are returning back to fashion: $OCN, $HLSS, $NSM, $ASPS, etc.

Patterns repeat all the time in financial markets. The only things that change are the names of the symbols involved. Corrections through price and time are a normal stage of any liquidity cycle and they should be embraced as playing a crucial role in the discovery of future leaders. The silver lining of all market corrections is that they highlight the strong stocks with organic demand or real alpha. Pay attention to stocks that make new 52-week highs or gain more than 3% on big down days. For example, during the selloff on Wednesday, one of the very few stocks that made new all-time highs was $CSOD. Then, it proceeded to spike more than 5% near the end of the week.

Most stocks dipped on Friday, when the $SPY struggled just below its already declining 20-day moving average. Here are six St50 members that showed relative strength:
RS June 14

In the book Hedge Fund Market Wizards, one of the featured traders (Jamie Mai) talks about two types of risk – identified and unidentified:

Markets tend to over-discount the uncertainty related to identified risks. Conversely, markets tend to under-discount risks that have not yet been expressly identified. Whenever the market is pointing at something and saying this is a risk to be concerned about, in my experience, most of the time, the risk ends up being not as bad as the market anticipated.

There are two major macro factors that seem to account for the majority of the recent market volatility:
– the re-winding of the Japanese Yen carry trade
– the discounting of potential tapering in the FED’s open market operations

The big question is how much of those risks have already been discounted by the market? They have already been covered extensively by the press, which by no means guarantees their impact will be reduced.

What I wrote about the market on June 6th continues to play out:

There is still plenty of risk appetite for buying dips in select U.S. equities. Today’s bounce does not change the big picture. We are still in a range-bound market environment with elevated volatility – an environment that is known to produce a lot of fake breakouts and breakdowns and be more favorable to mean-reversion setups from important technical levels. This does not mean that the market won’t look strong or weak for 2-3 days in a row. It will look strong or weak long enough to convince most market participants to lay in one direction and then it will swiftly pull the rug under their feet.

With that in mind, there are still plenty of opportunities for nimble traders that manage to quickly adjust to the new market environment and realize that many breakouts and breakdowns are likely to deliver a lot smaller gains than what we got used to in the first 5 months of the year.