Sunday, October 12, 2008

This Time *Has* Been Different

I was interested to see that the two most emailed articles from the NY Times were entitled "Those With Sense of History May Find It's Time to Invest" and "Switching to Cash May Feel Safe, But Risks Remain". This fits with the search results I reported for this blog, and it also fits with the general themes of my emails and conversations, which have been variations on the theme of "Are we near a bottom?"

The Times article starts with the idea that the most dangerous words for investors are, "This time it's different." But I follow market indicators and historical trading patterns, and I know that this time *has* been different. Out the window has been the "buy when VIX is above 30" guideline. Levels of oversold--from the number of stocks making new lows to advance-decline figures to rates of price change--that have led to rallies in the past have only led to more selling. In recent years, one of the worst trading strategies you could have implemented would have been to wait until market averages closed below their lower Bollinger Bands and then sell the market. Such a strategy of late has made considerable money.

This time is different in other ways, as well. The devastation to large blue chip companies, from banks to auto makers; the uncertainty about the very foundations of the financial system; and the comic/tragic flailing about by the government (one bank is rescued, another allowed to fail, then we buy bank debt, now we buy banks) all differ from past recessionary declines when a certain confidence in the Fed prevailed. Rightly or wrongly, we thought of Greenspan as the "maestro". There are no maestros today.

All of this is not to say we can't get a meaningful rally from here. If (limited) history is a guide, the sharp declines of 1932 and 1974 led to very sharp rallies. That same history finds that market returns after those rallies were subnormal for years to come. Historic declines tend to produce historic shifts in attitudes toward risk, and those lead to years of base building before a new generation of investors can express confidence in markets.

It's understandable that shattered investors hold out hope of being made whole. But hope is not a financial strategy. As a psychologist, I understand and empathize with the desire to believe that this time isn't different. As an investor, I have to view that desperate hope as a market indicator.