Tuesday, July 15, 2008

The crowd is wrong again: Dow closes below 11,000

One of the cornerstones of my investing philosophy is that the majority usually gets it wrong. For example, if most investors think that the market is going to stop falling and start rallying, then the market will probably continue to fall.

My online polls (on the sidebar to the right) are there to see what the majority thinks of the future, and the idea is that the majority will be wrong in these surveys as well. So far the strategy is working pretty well. One poll which closed earlier this year asked readers what they were invested in, and the majority (68%) answered "stocks/mutual funds," which so far have been the worst investments now that the market is at a 2-year-plus low.

Now a plurality has made an incorrect forecast. Another poll of mine which closed earlier this year asked readers where they thought the Dow would bottom-out in the current bear market. I gave four choices in 2000-point increments, and the largest number of respondents (36%) answered "above 11,000." The Dow just closed at 10,962 today, so the method has come though again.

So far in the current poll on gasoline prices, a large majority (62%) thinks that prices will "linger between $3 and $6." This is either good news or bad news, depending on whether the majority are too high or too low!


Anonymous said...

Spoken too soon? I took the survey some time back and still believe the Dow has hit its 2008 low. If I could have been more specific on the survey I would have said Dow 11,000, S&P ~1200. However, you have been right-on about a lot of things so I am very interested in your opinion. Is this near the 2008 bottom? The financials seem to lead the S&P and they were up over 15% today alone after being beaten down over the past month. Is this the start of a "end of the year bull run" (up about 5% by year end from here)or just a head fake (in your opinion). I know you still have your S&P 900 prediction but what is the approximate time frame? I hope you don't mind the questions. I really enjoy your blog!
John from Colorado

Jody said...

Thanks, John.

There have now been four "big up" days since the May 19 S&P peak of 1426: June 5 and 13, and July 8 and 16. Every one of those jumps caused a wave of "the bear market is over!" euphoria, and the first three at least were just head fakes.

Now, every smooth decline like this comes to an end eventually, so one of these big up days will end up being the start of a genuine "sucker rally." However, I haven't seen any signals that the long-term bear market is over, so I don't think we're at the bear market bottom yet.

We may find out today whether yesterday's jump was the real thing or just head fake #4.

Anonymous said...

Thanks for the comments. Just to clarify, you believe this could be either the start of a "genuine suckers rally" or a head fake but not the start of a longer term bull run (increase in S&P of ~5% between now and years end 2008 and then up another 10% by the end of Q1 2009). I'm with you on market timing and I'm trying to make a rational decision about my positions, but I'm feeling like the market is a "tweener", not likely to move much between now and the end of the year, other than the "noise" that occurs in between. But I would like to understand the general market trend better. Do you think the market will go below Dow 10000 between now and years end? I see you are 100% in SDS. Are you sticking with that position? Also no worries, I'm totally responsible for my investment decisions so I'm not trying to put responsibility on you. I really do value your input given your track record. Hope to see you in Colorado some time soon.
John from Colorado

Jody said...

Hi John,

I can't put a date on any price level, nor can I say with 100% confidence that a certain price level will be reached.

I'm only confident of 2 things right now:

1) The long-term bear market is not over.

2) The 2-month decline since May will be ending soon, and a sucker rally will follow, after which the market will continue to decline.

The upcoming rallies and declines may be steep and head-spinning, or they may be shallow, leading to a "tweener" market as you suggest, but the market rarely flat-lines.

The market went nowhere between mid January and mid June, but there was still an early February maximum near 1400, a mid-March minimum in the 1200's and another mid-May maximum in the 1400's, so it's been possible to make money with SDS in the pre-March and May-July legs.

Anonymous said...

Thanks, that is very helpful. I will look to position myself to take advantage of the potential suckers rally, knowing full well, "make your money in the middle".
Are you familiar with CXO Advisory Group? Here is there description:
"The CXO Advisory Group LLC is a small market research and publishing company located in Manassas, Virginia, offering serious private investors, financial advisors and others information that may assist in investing and trading decisions.

This web site presents models, research summaries, analyses and reviews designed for objective, unique and concise value to experienced investors and traders -- a modicum of actionable conclusions filtered from a very noisy environment. Our default approach is to challenge any and all conventional market wisdom with analytical skepticism."
I would be interested in your opinion. I have been reluctant to disclose their web site because it seems like their track record is quite good, (they missed the 1999-2001 tech run-up) and I like to have a competitive advantage vs the masses. Their model utilizes earning and that really threw off their model in 1999-2002. Let me know if you find it valuable. I owe you! If not, at least I hope it is interesting.
John from CO

Jody said...

Hi John,

Unless I'm missing something, it looks the the folks at CXO are basically using earnings to predict the stock market. That's chapter 1 of "Investing in the Stock Market 101," so don't worry about beeing scooped! Bob Brinker, who I used to follow, also uses earnings to time the market, and he completely missed this bear market.

Anyways, in each of the model-versus-S&P graphs for their REY and RTV models, CXO has chosen an "average" P/E ratio, (or E/P ratio = earnings yield) and plotted a smoothed and shifted graph of that ratio that appears to kind-of sort-of move like the market. But they've chosen a different P/E (E/P) ratio for each graph, depending on the time frame! One graph uses P/E 20, another 16. Notice that none of their graphs go back any earlier than 1990.

In reality, the S&P 500's P/E ratio has varied wildly from under 8 to over 45. If in less than 20 years the CXO people have already missed a major bull market in the late 90's, and can't explain the current bear market, just imagine how many misses they would have had from 1927-1990.

Finally, the real problem is predicting future earnings. Back in October, nobody was predicting the earnings drop that we've had. Even if the REY and RTV models accurately matched the market with earnings, they can't work without an accurate earnings prediction.

And if one wishes to use earnings at all, it's better to use the more accurate "as-reported" earnings instead of operating earnings like CXO has. My understanding is that operating earnings don't even take into account the losses in the housing and credit markets. No wonder CXO is predicting such a large upswing later this year!

I might as well add here a theme that I keep hitting on, that earnings don't matter as much as they used to, because they're being spent more on buybacks and less on dividends. This makes stocks worth intrinsically less for a given P/E ratio than used to be the case. No earnings model can correct for that.