Markets bad, but no sign of capitulation

With markets in a non-stop freefall — Asian markets were down between 800 and 1200 points Friday morning — the chatter around whether or not we’ve hit the bottom is growing.

But many people worry that we won’t hit rock bottom until we’ve seen “market capitulation,” which means everyone’s so fed up with the markets that they’ve given up on investing.

“While we’ve had markets in pretty steady decline, volumes don’t really suggest capitulation yet,” says Norman Raschkowan, chief investment officer at Mackenzie Financial. “In meetings with investors and advisors, the sense I have is that people are maintaining focus on their longer term financial goals and their personal plans.

“I don’t sense a degree of panic from the average investor that you might associate with these kind of movements in the markets.”

In a bull market, investors use market pull-backs as a buying opportunity, and the reverse is generally true in a bear markets — rallies are often used as selling opportunities. So far, Raschkowan hasn’t seen this kind of selling.

“You really haven’t gone through that phase yet,” says Raschkowan. “You’re going to have that churning, and it will seem like [the market is] bouncing along the bottom for a bit.”

It’s extremely unlikely we’ll see stock markets hitting zero, but it is still troubling when the majority of investors throw in the towel. “There’s definitely a bad psychology out there right now,” says Bruce Curwood, director of research and strategy at Russell Investments Canada. “People are concerned about the economics of the situation and the deleveraging that’s occurring. Investors are playing out different scenarios and some are not so good.”

When market capitulation happens, it usually results in a rapid sell-off, which many people thought was in the cards on Friday morning, as Asian markets were down between 800 and 1,200 points and the futures for the major American indices were halted when they hit their daily limit.

So far, the markets haven’t plummeted as badly as many expected, but there’s a good chance investors will capitulate at some point. “There are a number of investors out there and most of them are not informed,” says Curwood. “They get panicked by headlines in the paper, so some people run for the exit. As people sell out, that’s the point you talk about market capitulation, when retail investors throw their hands up and say I want out at any cost.”

Jeffery Shaul, president and CEO of Robson Capital Management, says market capitulation tends to happen all at once. There’s usually a large decline that occurs throughout the day, but he says we haven’t seen that yet. And, that might not be a good thing.

“What often happens to mark the bottom is an oversold market where you get all these sellers going out at once and capitulating,” he explains. “But this kind of steady decline means people are holding on, which suggests we’re not at a bottom.”

Shaul expects more problems to crop up in the American economy before the markets turn around. He’s worried about rising credit card default levels in the U.S., and when major corporations are forced to re-evaluate their pension assets. “You’re going to find significant deficiencies in funding, he says.

“Then you’re going to continue to see worsening in the real estate market and significant layoffs,” he adds.

Curwood is slightly more optimistic. He says markets always come back, and with government intervention, it’s likely things will turn around; he’s just not sure when that will happen.

But it’s a good sign that Warren Buffett is still planting money into the market, he says, because if he’s doing it then things can’t be that dismal. “He’s one of the best investors in the world and he’s trying to take this as an opportunity to invest.”

It’s a strategy others should follow. Curwood explains that if your clients are already invested in the market, they are already down, so why sell? “It’s not the time to make a major decision or do anything dramatic,” he cautions. “Markets are moving; there are huge swings over the course of the day. Just hunker down, put the money in a strategy you can tolerate for a long time. Don’t sell out after going down 35%.”

Curwood points out that there are still a lot of companies with great value, even in the financial sector. He explains that when things get bad they get tarred with same brush, which means entire sectors are down whether they should be or not.

“When financials fall, it hits everything, but some of them won’t be as affected,” he explains. “Some have better balance sheets, better capitalization. Those are the ones sophisticated investors are looking at, particularly when starting to look at market value versus book value. To those investors, that’s a good buy.”

For the average investor, dipping a toe back into the market is still a frightening proposition. Raschkowan says clients may be waiting on the sidelines until they can get a better grip on what is happening.

“I think it will be mild in North America, but I think we will go through a recession,” says Raschkowan. “People will now be waiting to se how companies have fared as they’ve had to work through this period of capital market disruption and slowing growth.”

Shaul points out that it’s not too late to invest in a lower volatility fund. His own Robson Hard Assets Fund is only down 0.4% year-to-date.

“I would have said six months or a year ago that it’s a good time to take some money off the table and put it into something with less volatility, but not everyone took that advice,” he says. “Still, any time is a good time to balance their portfolio, and having a piece of it that’s not correlated to a major index reduces risk.”

So should the market fear market capitulation or not? For the savvy client, it can’t come soon enough. “Some of the best opportunities in the marketplace occur when the retail investor is running and taking all their money out of equities,” says Curwood. “But, on the flip side, when retail investors are throwing their money at the market, it’s time to get out.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(10/24/08)

Bryan Borzykowski