Sentiment, negative or positive, is contagious and triggers a sequential response in bourses across the world.
We have an index of phone calls at Orpheus. This is an internal sentiment index that we use. Higher the number of calls received in a certain week, stronger the market sentiment. The week that went started with frantic calls regarding market volatility.
“I am long on the market after markets fell 10 per cent, but they don’t seem to stop falling, and now Dow is down too, what should I do?” Another query was, “When will this fall stop. How low can it go?” Another one involved Fannie Mae, Freddie Mac, and Merrill. “What was their future?”
Another was regarding the ban on short selling and how it would modify market behaviour? “What else will the regulator do? Open interest has increased in the market, what does it mean? I am still in doubt regarding the bottom. Does doubt about a bottom make it a better bottom?”
Of course, once in a while we also have the regular confessions regarding leverage and need for vacations and detachment. Markets do take a toll on human psyche, and, more the emotional maturity better it gets for the investor, trader or speculator.
On the first impression, the frantic call index spiking to near panic lows, or capitulation bottoms might look like a strange phenomenon. But a deeper thought and you can start seeing a cycle. We at Orpheus monitor market sentiment.
The need to understand sentiment is so strong that whenever we conduct a conference with more than 50-100 people, we do a survey. We did one in Dec 2006, weeks before Romania was to enter the European Union. I raised my hand and asked the large group, how many think markets will become half from here. Not even one hand rose. Jan 2007 saw a collapse of 30 per cent after Romanians celebrated the EU entry and went across the Hungarian border to have coffee without being asked for visa or passport details.
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On another occasion in 2007, the same question saw another hand raised along with mine. This time it was a research head of an institutional brokerage company. But we were still in a minority, two loners who believed markets can halve in value.
Market sentiment is like this, lonely at tops and overwhelming at bottoms. Tops we are kings and bottoms scared prisoners of war, searching for survival trenches to hide in. Capitulations are chaotic while euphoric upmoves are celebrations. Tops are when we celebrate and dine with our broker and bottoms are when we fire and sue him.
This is the reason the frantic call sentiment index never spikes at a market top. It is only after markets start falling that the bells start ringing. This is human nature. We pay more for put options in a market collapse, than we pay for calls in a euphoric rise. Fear remains a stronger motivator than greed.
This is why capitulations can be measured easily compared to euphoric tops. There are also more signals near a bottom than there are exhaustion signs at a top. Above this, price rockets can push the markets higher, but the market has a limit to where it can fall to, 50 per cent, 60 per cent, 90 per cent are clear limits on the downside. But upside is technically unlimited, till the moon.
There are of course other problems linked with capitulations. Even if we hit or identify a capitulation bottom, prices take more time to rise than to fall. We take more time to build than we take to destroy. We move from margin lending schemes at market tops to banning short sales at lows. There is a complete history of short sale bans and revokes.
The proponents of globalisation have also contributed to this capitulation. They just made it global. There are cycles of liberalisation and protectionism. We open up and build walls cyclically. Globalisation brought free trade, economic growth, and consumerism. Along with all this came speculation and global capitulation where contagions happen together around the world. We talked about one such impending capitulation in The October low article.
Global contagions and capitulations have group power. When many countries fall at the same time, it creates a stronger sentiment than what a single market collapse would have evoked. Group power hence has more signal power. If we have 10 sectors in the market and all of them are in gear, that’s just the turnaround signal one needs, everything falling and negative at the same time. What happened now was a global contagion. Year to date, Russia is down 50 per cent, Shanghai composite is down 60 per cent, Brazil BVSP and Indian Sensex are down 30 per cent. And along with this if you hear about bankruptcies and bailouts, the panic is bound to be global.
Capitulation, the sentiment tool, works differently for stocks and indices. It is more of a market wide tool than for stock specific. It is like comparing a large degree cycle with a small degree cycle. Both degrees work, but the larger degree is more impactful. Above this Indices can be reconstructed, this is why Dow Index after the 1929 collapse of 90 per cent survived, as new industries, sectors and components took over.
But when stocks collapse 90 per cent there is not much study that can be done. All the 90 per cent collapses look the same. The market signal for the company is clear and revivals or resurrections are potential miracles. What happened to Fannie Mae, Freddie Mac, AIG, Lehman and Merrill leaves not much to say.
Capitulation cycles can also be linked with simplicity cycles. Markets wake up and ask, “Why we made it all so complex?” There is a strong need to simplify things again. The need for affiliation increases and need for achievement decreases. It is a clear move from the conscious to the subconscious, and introspection.
Market knowledge also moves from short term to long term memory. The bigger the crisis, the deeper it gets into market memory. Capitulation is like grieving and mourning. It is a five stage process - anger and intense emotion, denial, guilt, depression and sorrow and finally acceptance.
Sentiment in terms of news also reaches historic proportions when market hits capitulation lows. The bulls thanked the Federal Reserve while the bears blamed and cursed the bailouts.
We are in historic times and such high number of capitulations for us may make the stock study redundant, but as a panic extreme, such extreme sentiments still favours potential impending bottoms rather than continued precipitating declines.
We just need to work on timing more, did it happen already or is it coming in October? A smarter investor, on the other hand would wonder “What capitulation?” His green stocks like Vestas Wind, ITT Corp, First Solar are still positive for the year.
The author is CEO, Orpheus CAPITALS, a global alternative research firm