Is This For Real?
Yesterday morning I started to write my weekly business column and I was watching as the market made a bold October 3rd move. Unusual to say the least since October has been treacherous at times. Even though historically, October has been a generally a pretty good month for investors. Still I saw something yesterday that struck me.
Yes, it could be investors responding to a possible oversold condition or it could be money moving back into the market to try and recover some of their losses over the year. Portfolio managers got hammered for nine months and now they are looking at losses on top of the fact that their cash positions might be quite a bit higher than their investors expect. So, put that cash back to work in names you lost money in. Now you can buy them 20-35% cheaper. I don’t actually know for sure but I think yesterday’s rally was a little of both.
In any event, it felt different.
I do have some experience with that capitulation effect, where investors just throw up their hands and say, I am done, I am wrong, I give up. You can see this periodically in individual stocks and yes, it does happen with sectors and the overall market as well. Honestly, I haven’t seen or felt any of that this year. What you rarely see, however, is capitulation on the buy side. It’s much harder to recognize and I am not sure it is actually a thing. Could we have seen that yesterday? Investors saying enough with the selling, let’s buy!
It actually doesn’t work that way, maybe small investors act that way but institutional portfolios do not. We can look at all the Meme stocks and say that investors can effect individual stocks in a capitulatory way but rarely will you see an institutional investor jump on top of a movement and want it done instantly (or in a day). The impact of that buying is weighed in metrics that every portfolio managers knows about and no PM wants to be the reason a stock is up 7% in one day or 25% for a week.
Yes, historically, there have been aggressive momentum buyers but those portfolio managers were given great latitude about how they got things done. Those guys have retired to Cape Cod. Now it’s plodding algorithms that weigh 30 factors before ever buying a share. They do this in microseconds. Leave as small a footprint as possible is the new mantra (actually, it’s been around for decades but today it is rule number one).
So, looking at yesterdays action was it individual investors getting back in? If it was, that is a very bad sign for a reversal. Retail investors are notoriously late to every rally or sell off. Was it the institutions reallocating all that cash? Or was it something else.
An educated guess is that we finally saw institutional money managers putting that cash back into the market. This rally was across the board and yet very little has changed in the Macro economic picture. Which furthers my belief that the institutions see a possibility of a decent quarter equity wise and they need to be in it to win it.
What we should see is a followup today. Repeated strength on a follow up is a very good sign. It is rare in that repeated strength only happens when large infusions of cash come into the market. That cash has to believe that prices are relatively cheap compared to where their positions were at an earlier time. What will throw a wrench into this institutional flow is if earnings fall off a cliff. Then you are invested in stocks with the same high PE’s that you had last year yet the price of the stock is down 20%. It’s a tricky situation because what will start to develop is that dreaded divergence we saw at the beginning of the pandemic. Stock prices didn’t reflect the actual health of the economy, they reflected a much rosier picture than actually existed.
I hate that disconnect. It is ripe for some serious damage as far as your portfolio is concerned.
One thing I will say is that even though there are so many negatives out there, I do believe that stock prices have come back to a much better level. PE ratios are closer to historical than at anytime in the last three years plus. So, relatively speaking, prices of equities last Friday were as close to fair value (mine, not the markets) as they have been in years. If I was an institutional money manager, I would have been buying into the close last Friday and continued yesterday, till stocks got a point where they started getting expensive to my fair value.
The follow up today at this writing, looks good and that, as I have said, is a positive. Can this buying sustain itself longer than today? Thats the question every PM has to ask him or herself. Did we see a long term bottom last week or will we continue to test the lows? If you look at it pragmatically and take into account everything investors should look at, you could make a strong case for testing lows but when has the market ever acted according to common sense?