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The Speculator
When the market panics, buy
As we ponder the tragic
events of last September -- and the past few dismal market years --
the numbers tell their own story: When Wall Street decides things
look darkest, prepare for a profitable dawn.
By Victor
Niederhoffer and Laurel Kenner
With all thoughts on the World Trade Center
disaster a year ago this week, we are devoting this column to
financial panics. Of course, it is unsavory to equate the tragedy of
lost lives with lost dollars. But the barbarity of attacking unarmed
people at work in the World Trade Center was above all an attack on
American economic freedom, the foundation for all the other
liberties.
Maybe panic is
the wrong word to describe what took place in the week the market
reopened after the attack. The 11% decline in the S&P 500
($INX)
reflected a new uncertainty that was real, not the emotional
overreaction associated with bubbles and their opposites. The end
result was the same, however. The market recovered when Americans
took the measure of their enemies and found them weak and
divided.
While moved by the suffering and ennobled by the
rescue efforts, there is much we can learn from markets about what
happened. It is clear that relevant U.S. agencies were woefully
unprepared for the attack. In his new book, “Breakdown,” journalist
Bill Gertz details how, time after time, the American spy
infrastructure was ill-equipped to forecast and prevent the
catastrophe. Lacking case officers in Afghanistan or enough Arabic
speakers at headquarters, U.S. intelligence commanders were capable
of studying bland electronic communications but not "huge stacks of
Arabic language documents that sat around and weren't translated.”
Prepare for the
worst
Being unprepared for market panics does not lead to
loss of life, but it leads to loss of wealth and choice. Don’t ever
fail to prepare for a panic before it happens. And don’t ever assume
that the prelude to a panic will occur the same way the next time as
it has in the past. Most important of all, the American way is to
invent independent solutions that address the needs and desires of
consumers and constituents. Let's tap into this creativity -- this
glorious system that has given us so much material wealth and
personal freedom -- to stay ahead of those who would compete and
destroy the American way.
In the rest of this column, we
describe a tested and innovative way to deal with market
catastrophes. It is inspired by the archetypical American
businessman Stan Novak, who for 40 years in the pursuit of his own
happiness provided for the changing and pitiless desires of
Americans to improve their mobility, comfort and appearance through
the humble provision of canes.
Last week, we wrote about the
sad passage of Novak’s shop, the last purveyor of canes in Manhattan
(See “Hard-earned
walking canes and new companions.”). Novak had supplied walking
sticks for us to send to readers ever since we started writing
columns together in early 2000. The canes had a special meaning for
us because of a passage in a 19th century book on investments about
old speculators taking out the canes from their closets in times of
panic, hobbling down to Wall Street to buy good stocks, taking
profits and hobbling back home to their splendid mansions.
When the worst becomes the
routine
Is it still possible to profit from panics?
It was guaranteed to happen that just as we started sending
out canes as prizes, one of the worst, most drawn-out stock market
declines in history began. Many a speculator who hobbled down to
Wall Street since the turn of the 21st century has found herself
beaten over the head with her own cane as the Nasdaq
Composite ($COMPX)
fell from 5,000 to 1,200. Even the Dow Jones Industrial
Average ($INDU),
supposedly made of stronger stuff, is down 3,000 points from its
peak of 11,722.
Whenever we noted in our column that stocks
have gone up 1.5 million percent in the last 100 years and we
expected them to do the same in the next 100 years, dozens of
readers wrote in suggesting that our editors seize our canes and use
them to give us the hook.
As the market relentlessly drifted
down, vicious panics of shorter duration were not lacking. In fact,
dangerous declines have become routine, occurring in five of the
last six years. (Two of those declines took place in the great
pre-millennial bull market of 1997-1999.)
- In 1997, the collapse of Southeast Asian markets and a
550-point decline in the Dow shut down Vic’s hedge fund after a
30-year record of high performance.
- In 1998, the implosion of a big Connecticut hedge fund,
Long-Term Capital Management, paralyzed credit markets.
- In 2000, the Nasdaq fell 25% in one terrible April week.
- In 2001, the 9/11 tragedy took the market close to a four-year
low.
- In 2002, the market fell 18% below the World Trade Center
disaster low, apparently without any proximate cause at
all.
We hear lots of people today say they won’t be happy
until all the “dip-buyers” go under. Not until every last bit of
optimism has been crushed, they say, will the market recover.
Vic tested the strategy of buying in panics several years
ago and reported the results in his 1997 book, "The Education of a
Speculator.” He concluded that that the old speculators had it right
with their hobbling and buying. Given the changes of the last five
years, we decided that an update was in order. We offered a bounty
for a new study, and the prize went to Shi Zhang, Vic’s apprentice.
Zhang looked for market drops of 10%, 20% and 30% occurring over 30
trading days and calculated the market’s change 5, 10 and 20 days
after each decline. Here are his results.
Does buying in panics pay?
Dow Jones Industrial Average, Jan. 2, 1915-Aug.
29, 2002
| 30% decline in 30 days (27 trades)
|
|
|
5 days after |
10 days after |
20 days after |
| Mean |
|
4.6% |
6.8% |
8.3% |
| % up |
|
74.1% |
85.2% |
85.2% |
|
|
|
|
|
| Last 5 observations |
Closing price |
5 days after |
10 days after |
20 days after |
| 10/26/1987 |
1,793.93 |
2,014.09 |
1,900.20 |
1,923.08 |
| 10/19/1987 |
1,738.74 |
1,793.93 |
2,014.09 |
1,949.10 |
| 4/13/1932 |
61.18 |
59.75 |
58.92 |
59.01 |
| 12/17/1931 |
73.79 |
76.02 |
77.90 |
84.36 |
| 12/16/1931 |
76.49 |
79.55 |
77.14 |
79.39 | |
| 20% decline in 30 days (165 trades)
|
|
|
5 days after |
10 days after |
20 days after |
| Mean |
|
1.0% |
1.3% |
1.5% |
| % up |
|
57.6% |
57.6% |
54.5% |
Last 5 observations |
Closing price |
5 days after |
10 days after |
20 days after |
| 7/23/2002 |
7,702.34 |
8,680.03 |
8,274.09 |
8,872.07 |
| 9/21/2001 |
8,235.81 |
8,847.56 |
9,119.77 |
9,204.11 |
| 9/20/2001 |
8,376.21 |
8,681.42 |
9,060.88 |
9,163.22 |
| 11/24/1987 |
1,963.53 |
1,848.97 |
1,902.52 |
2,005.64 |
| 11/23/1987 |
1,923.08 |
1,842.34 |
1,868.37 |
1,978.44 | |
| 10% decline in 30 days (959 trades)
|
|
|
5 days after |
10 days after |
20 days after |
| Mean |
|
0.0% |
0.0% |
0.1% |
| % up |
|
50.6% |
53.2% |
55.2% |
Last 5 observations |
Closing price |
5 days after |
10 days after |
20 days after |
| 8/6/2002 |
8,274.09 |
8,482.39 |
8,872.07 |
|
| 8/5/2002 |
8,043.63 |
8,688.89 |
8,990.79 |
|
| 8/2/2002 |
8,313.13 |
8,745.45 |
8,778.06 |
|
| 8/1/2002 |
8,506.62 |
8,712.02 |
8,818.14 |
8,670.99 |
| 7/30/2002 |
8,680.03 |
8,274.09 |
8,482.39 |
8,824.41 |
| 7/26/2002 |
8,264.39 |
8,313.13 |
8,745.45 |
8,872.96 |
| 7/25/2002 |
8,186.31 |
8,506.62 |
8,712.02 |
9,053.64 |
| 7/24/2002 |
8,191.29 |
8,736.59 |
8,456.15 |
8,957.23 |
| 7/23/2002 |
7,702.34 |
8,680.03 |
8,274.09 |
8,872.07 |
| 7/22/2002 |
7,784.58 |
8,711.88 |
8,043.63 |
8,990.79 | |
We
conclude that buying in panics has been just as good as ever
recently, if not better.
We wrote in our last column that we
were saddened by the demise of Novak’s shop. But paradoxically, we
were also uplifted. Canes may be purchased over the Internet
nowadays, and the farthest most of us have to hobble for trading is
to the nearest computer or telephone. In 40 years of business, Novak
served those who wished to achieve freedom of mobility by adapting
to their new needs. Then when new solutions came along -- including
electric wheelchairs and hip replacement surgery -- he was replaced
by an innovative set of new purveyors. That’s the mechanism writ
large over the millions of businesses in this country -- the system
that gives us the right product, the right degree of safety, the
right degree of flexibility and the right degree of freedom to
succeed that is truly the American way. The system works flawlessly
without any commands or confiscation from governmental authorities.
Should not Novak, as a representative of the American business
system, be a model for the spirit of freedom, innovation and
altruism that have arisen from the World Trade Center
catastrophe?
Canes have been around for thousands of years.
Egyptian kings held them as a sign of authority. An entire branch of
Korean martial arts is devoted to fighting with them. Ben Franklin
bequeathed his gold-headed cane to George Washington, according to a
1995 article in Smithsonian Magazine; that walking stick is now part
of the museum’s 2,000-cane collection. Every newly elected U.S.
president has been presented with a cane since the early days of the
republic. And despite the advent of brilliant new replacements, we
have every reason to believe that canes will continue to be useful
in this century -- and so will buying in panics.
Final note
Old-time trackers tried to
suss out the thoughts of the animal or person they were after, and
we suspect that traders might profit from their example. We will
send an official Old Speculators’ Association cane to readers who
come up with the most useful responses to the following
Gedankenexperiment proposed by trader Henry
Carstens:
What would it be like to be the market instead of a
student of the market?
Assume you are constrained by
fundamentals as an animal is constrained by habitat, but you have
free will within your habitat.
What does your habitat look
like?
What do you do in the next time frame if:
- Your disposition is benevolent?
- Your disposition is malevolent?
- Your focus is short-term utility maximization?
- Your focus is long-term utility maximization?
Kindly
e-mail your response to request@dailyspeculations.com.
At the time of publication, neither Victor Niederhoffer
nor Laurel Kenner owned shares of any equities mentioned in this
column. They trade in derivatives instruments. They may be net long
or net short depending on the market conditions of the moment.
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