The Problem with "Bear Market Rallies"

Of late, Mr. Market has seemingly begun to look a little more on the sunny side, instead of remaining moody and depressed which was his prevailing mood for the past 17 months. Just to remind, the Singapore Stock Market's index (STI) has risen in 4 straight weeks, with only 5 "down" days out of a total of 20 trading days (meaning 25% down, 75% up). Many may recall that it was only on March 6, 2009 when the Index hit a 5.5 year-low (of 1,456.95), after which it has so far rallied around 25% to its current level of 1,820.87. The sharp rebound has had many pundits and investors shaking their heads and rolling their eyes, and provided no end of amusement to the author of this blog (yours truly). I will proceed to explain why below, so dear readers, please be patient and read on.....

Interestingly, most analysts and economists who were interviewed were decidedly bearish and pessimistic. They pointed out (rightly so) that the economy had yet to bottom, manufacturing data was still weak, exports had fallen off a cliff and unemployment (in the USA and Singapore) was set to increase even further. Against such a bleak backdrop, how could rallies possibly sustain and how could Mr. Market be perceived as being more sunny and optimistic for an extended period of time ? The even more cynical ones point out that corporate results reporting season is due in a few weeks' time, and the probability of more companies reporting dismal earnings and lower profits would cause "reality" to sink in and give Mr. Market a blow in the face for being too exuberant. In short, there's nothing much to look forward to given that data, numbers, facts, figures and sentiment are so poor right now. Even if there was some hope that things were "bottoming out", these experts are quick to point out that more certainty needs to come along in the form of hard data to justify any cheer that the gloom is about to lift.

The above paragraph shows the distinct difficulty in what investors would term the "tricks" of Mr. Market. To quote a very over-used cliched line: "Bull Markets climb a wall of worry". This basically means that a bull market has to overcome an amazing load of negative news, all the while reaching for greater heights and overcoming adversity (and doubt). The greatest difficulty faced by pundits and seasoned experts who observe markets is in differentiating between a bear market rally (of which many occurred during The Great Depression) and the start of a genuine bull market (or even if not, at least an end to the current bear market). Understandably, the confusion often lies in the fact that no one can predict future turn of events well enough to state if economies will recover, and how soon that will be, and to what extent. Investors are also unaware if markets have priced in the most pessimistic scenario in terms of earnings growth and industry doldrums, and thus prices only have one direction to go in future which is: higher. This confusion and lack of clarity is the main reason which keeps investors from placing their money in good, high quality companies for fear that "the bottom has not been reached".

In order to adopt good value investing practices, one must identify suitable value and purchase at a price which provides a decent margin of safety. In the case of Mr. Market's moods, I have often used the STI as a rough barometer of sentiment, and thus have made my purchases on days when the Mr. Market is pessimistic, rather than when he is exuberant. The fear that "the bottom" is still out there does not make sense to me because I believe it is impossible to time the market - thus an investor should just look out for good value and purchase within his means. If we have evaluated a good company and understand its business characteristics and are confident with its prospects, we should feel comfortable buying at current depressed valuations. Too many people live with the perpetual fear that Mr Market's moods will determine if their investments will do well or badly, but then one must remember that it is his pocketbook which we have to take advantage of, and we must NOT be lulled by his schizoprehnic mood swings.

As long as one purchases with a value mindset, one does not have to care if a rally is a "bear market rally" or a "genuine rally". That is the focus and discussion for analysts, pundits and prognosticators who make a living out of predicting and commenting. They are fun to read and amusing to follow but offer no real value in terms of building wealth through the ownership of equities, as most of them are armed with a trading mindset to boot (e.g. sell into the next bear rally after prices have risen 10% etc). With the fricitonal costs relating to frequent trading, volatile market mood swings and the risk of getting whipsawed often by changing sentiments, I find it hard to see how most traders can consistently make money.

In adhering to my value investing principles, I have, of late, also learnt more about the way businesses and companies function during long periods of drought where financing dries up, as well as how companies cope with adversity (e.g. slashing selling prices, cutting costs aggressively by retrenching). It has been a good learning experience and I now understand businesses better than before and it will assist me in my evaluation of more companies to own in future. I am glad that I have managed to escape a severe permanent loss in capital through the concepts of value and margin of safety - it could have been a lot worse had I been speculating recklessly or if I had purchased "over-hyped" companies with flawed business models.

Note: Ezra Holdings Limited is expected to release its 1H FY 2009 results on April 6, 2009. I will do a review shortly after I have digested the numbers and facts.