Iron Capital Insights

  • Iron Capital Insights
  • February 3, 2016
  • Chuck Osborne

Capitulation

Markets are unpredictable in predictable ways. This malaise which set in at the beginning of this year just won’t go away. Even with the benefit of some positive days and even weeks, this selloff isn’t over yet. And it won’t be over until we get a capitulation.

Capitulation is the last emotional stage of every market cycle. Markets go up on apprehension, grow on optimism and peek on exuberance. They begin the downward leg of the cycle on denial, fall on fear, and finally hit bottom once people have capitulated. That is the pattern. It is easy to recognize in hindsight, but not so easy when we are in the midst of things.

We are not there yet. Everyone is in a bit of a funk, but I’m not sure I would call it fear. No two downturns are exactly the same, but this one reminds me a bit of 1998. In 1998 I had not quite lost all my hair but was getting close. The hair on the sides was a little less gray. Russia was in big trouble. The giant hedge fund, Long-term Capital Management, which had not one but two Nobel laureates on staff, was collapsing. Asia was having a financial crisis. We, however, were just fine, except for the stock market.

It isn’t exactly like that now, but there are problems out there in the broad world. China is growing more slowly; oil’s plunge is hurting many commodity-based emerging market economies; the developed world is already stuck in a slow growth rut brought on by too much debt. We keep slogging along, but not fast enough to hold up the global economy.

Having said that, unemployment has gotten much better. Low oil prices may be rough on oil companies and emerging market countries but it is pretty nice for the average person commuting to work who now has a few extra bucks in the pocket to use elsewhere. That isn’t a bad thing. We are just fine.

Most stocks are not expensive. We have talked about the fact that last year’s market was dominated by very expensive stocks flying high, but when one looks beyond those few, the rest of corporate America is on sale. That is a good thing for longer-term investors.

There seems to be a consensus that this early year selloff has been overdone from the start, so why won’t it just go away? Well, this selloff has nothing to do with investors. It has been driven from the start by speculators, mostly computerized speculators, and they will not stop selling until they see a sign: Capitulation. The big wash-out. It is knowledge like this that makes trying to time the market so tempting. Everyone knows it has to happen.

The problem is there is no set schedule. We could have another rally like the one we had in the fourth quarter (which in hindsight seems like a false rally) before falling again, or it could happen tomorrow and be over by week’s end. This is why timing never works.

No, all the prudent person can do is check and double check the quality of her holdings and take comfort in the knowledge that this too shall pass. What we own is solid and will be valued higher within a relatively short period of time.

Hindsight is an interesting thing. The market downturn in 1998 seems like just a blip now, but it didn’t when we were in it. That feeling, that this will last forever, is what eventually brings on the very capitulation which then leads to the next leg up. Waiting is the hard part. But this will indeed pass.

Chuck Osborne, CFA
Managing Director