Saturday, October 20, 2007

The Velocity of Downturns

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One signature of recent markets is how downturns, in general, happen in a much more constrained period of time than moves upward. I touched on this in "Buybacks Continue at Record Pace" last weekend.

And our pullbacks will be shorter in duration, rarer in nature, and perhaps more violent as the movement down is compressed into weeks versus months. Perhaps.

So when we have weeks like we just had we have to ask ourselves, would it of felt so bad if this sort of downturn happened over 3-4 weeks, rather than 1 week? Instead of getting hit for 1.5% down on Mon-Tue, or 2.5%+ on Friday alone, would we have felt such trepidation if the moves were -0.4%, -0.6%, +0.8%, -1.0%, -0.3% over the course of a week, for 3-4 weeks in a row? Probably not.

I spent some time looking at the major indexes and to put it in perspective we have effectively erased all gains from the post Fed cut. At 13,522 we are right back to where we were before 2:15 PM on September 18th, when the Fed decision sparked a massive run. All the glee and cheer that the Fed can bail us out of every problem afflicting the economy? Apparently erased. I kept mentioning this was like a keg party and enjoy it while it happens and lock in your profits, because it made little sense considering "why" the Fed was in such a rush to cut so severely. Now, at least in the indexes, if not in individual names - those gains are gone.

How violent is the downturn in relation to the upturn? It took 18 sessions to rise from 13,500 to 14,280 - a gain of 5.8% to take the Dow to all time highs (reached last Thursday before the late day intraday reversal). It took only 6.25 sessions (I am counting the last quarter of a day last Thursday) to erase it all, so a 3:1 ratio from time frame to go up versus time frame to go down. While the numbers are not exactly the same in the NASDAQ, S&P500, and Russell 2000, the scope and direction are identical.

So the takeaway is, while this feels bad emotionally, would you feel the same emotionally if the downturn had taken place over 3-4 weeks rather than just over 1 week? The ability to keep emotions out of your investing as much as possible is key, so try to keep that in mind. As I mentioned last Thursday, these 1 day reversals generally (not always) mark a change in psychology - we had one on August 16th (magically the day before the 'surprise' discount rate cut by the Fed aka surprise to us, not a surprise to 'someone'), and the market went on a major tear for 2 months and we had one last Thursday and thus far, we've lost 5.5% or so in a blink of the eye.

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