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Where's the Dow Heading Next? One Market Veteran Has Already Told Us |
[http://www.streetauthority.com/includes/article-top-ao.htm]Published:
October 13, 2008
Jesse Livermore knew a thing or two about the market.
Livermore was one of the world's most successful
traders -- he shorted the market just before the October
1929 crash and walked away with $100 million, roughly $1.2
billion in today's dollars.
This Wall Street legend had an inauspicious beginning
in Boston's "bucket shops," sketchy casinos where bettors
could wager on stock prices being spit out on the ticker.
Livermore was so good at spotting patterns in stock prices
-- and in consistently beating the house -- that he was
banned. What Livermore had recognized -- and what gave
him an edge -- was that most market participants were
motivated not by reason but by human nature. This was
especially true when the market was at its highest and
lowest points.
In a chaotic system, Livermore latched on to a constant:
"I absolutely believe that price movement patterns are
repeated and appear over and over, with slight variations,"
he said. "This is because humans drive the stocks, and
human nature never changes." According to Jesse, "All
through time people have basically acted and reacted the
same way in the market as a result of greed, fear, ignorance
and hope."
The current market bears this out. All bubbles and
busts, at the top and the bottom, look the same. They
all follow Livermore's pattern.
First, he said, there's greed. It was certainly
present on the part of mortgage lenders, and among borrowers
who wanted to make big money on homes they couldn't afford.
Greed also was evident on Wall Street, where some brokerages
took huge leveraged gambles on mortgage-backed securities.
And as the losses began to mount, many still held on to hope
that things would turn around, that the housing market would
quickly rebound and that the Federal Reserve's policies
would pull us out of a crunch with minimal damage. As
we know, this simply wasn't the case.
Then there is fear. Fear that Congress would fail
to address the problem led to a recent 777-point drop in the
Dow in a single day. And the culmination of fear that the bailout
won't actually solve the current crisis has caused the drops we've
seen around the world over the past two weeks.
This fear wouldn't exist if it weren't for its close
cousin, ignorance. People who don't understand central
banking, corporate fundamentals or macroeconomics are
selling stocks based on gut reaction, which is telling them
to get out of the market before it goes to zero. That
is the opposite of what the smart money should be doing.
Bankers are also hamstrung by ignorance. That's
not meant unkindly. They're not stupid, they just
don't yet know what their mortgage-backed assets are worth,
so they're hoarding cash and restricting lending.
Truth be told, this situation is playing out exactly as
Jesse Livermore's rules said it would. And since
that's the case, we know the eventual ending of this story
-- a rising market.
How can we be so sure? It has always happened
this way, and it will always happen this way.
Livermore recognized the consequences of human emotions in the market's action 70
years ago, and he's still right today. Eventually fear and
ignorance will be overcome and calm investors will begin to
ratchet prices back up.
History proves
this:
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From October 1929 through June 1932, investors
suffered the worst bear market in history. The
Dow fell -89% over that time frame. But just one
year after bottoming, investors were enjoying gains
of +118%.
In July 1982, the Dow had bled -18% from its
year-earlier level. Twelve months
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Bear
Market |
Loss |
Gain 1-Yr.
Later |
|
1929-32 |
-89% |
+118% |
|
1981-82 |
-18% |
+52% |
|
2000-02 |
-27% |
+33% |
|
2007-??* |
-33% |
??? |
|
*Through 10/12/08 |
|
later, the index had
rallied +52% -- and 36 months later the blue chips were +78% higher than
their low.
The bear market of 2000-02 saw the
Dow fall -27% from its peak, but once again the market
quickly turned positive for investors. A year after
reaching its low, the Dow had risen +33%.
In all three of these cases, stocks
sold on fear and ignorance only to later be redeemed by
investors who were certain things would improve. That
confidence was borne out by a growing economy that has never
failed in its continued expansion -- but has had a few ups and
downs along the way. Livermore would have recognized
this immediately.
Now, we're not technical traders.
We believe in solid, fundamental analysis. We don't
think it's wise to buy stocks based on charts, we think it's
wise to buy stocks based on spreadsheets. That being
said, history shows us that the market will rebound. The
question then becomes one of timing.
Livermore -- whose understanding of
human nature has been proven conclusively accurate for 70
years, offered his wisdom about timing the market:
"Never try to buy the bottom, he
advised, and never try to sell the top." The words of a
man who understood greed, fear, ignorance and hope.
Good investing!
Andy Obermueller
Co-editor
StreetAuthority Investor Update
http://www.StreetAuthority.com
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