Date: Wednesday, July 23, 2008
Author: The Global Guru
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While most investors were dumping stocks across the board early last week,
The Economic Times of India reported that billionaire global investor George
Soros had gone on a buying spree in the Indian stock market. Soros' Quantum fund
has invested close to $140 million in India since February and has picked up the
pace of its purchases during the past couple of weeks. In placing his bets in a
high risk, highly volatile market such as India, Soros is trying to do what very
few investors do successfully -- which is to pick the bottom of a bear market.
Granted, $140 million is not a huge bet for Soros' Quantum Fund. But it does
signal a shift in the thinking of the granddaddy of hedge-fund managers.
Nor is Soros alone in apparently betting that the current global financial
crisis may be turning. The chairman of Deutsche Bank said Friday that the credit
crunch was "at the beginning of the end," thanks to banks and regulators who had
taken action to deal with the crisis. J.P. Morgan's investment banking division
recorded its second-best quarter ever as the bank as a whole reported
better-than-expected results last week. In addition, a number of other U.S.
financial institutions have reported better-than-expected financial results
during the past week. George Soros Turns Bullish: Is the Market Rally For Real?
The question remains whether the current turn in the markets marks the beginning
of a sustained rally. The bulls are trotting out a whole host of arguments.
First, high volatility in the market often signals a market turn, and the VIX,
or volatility index, is trading around the 30 level. That's near the peak it
reached in March at the time of the Bear Stearns bailout -- though it's still
less than the level of 40 it hit in 2002 and after the collapse of Long-Term
Capital Management (LTCM) in 1998. Second, the dividend yield on some major
markets like the FTSE All-Share (the broad-based British index) is approaching
the yield on 10-year gilts, or government bonds. The last time the U.K. stock
market yielded more than gilts was in March of 2003, marking the end of the
2000-2003 global bear market to the day. Third, many European markets --
including Belgium, France, Ireland, Italy, the Netherlands, Spain and Sweden --
are trading on P/Es in single digits. Even on Wall Street, stocks are cheaper
now than they've been in more than a decade, with the Dow and S&P 500 index
trading at forward P/Es of 12 and 13 respectively. Finally, market contrarians
also pointed to a classic buy signal from Merrill Lynch's survey which confirmed
that as a group, global fund managers have been the gloomiest they've been in a
decade and are sitting on record high cash positions. Yet let's not forget that
there was no dearth of bullish arguments in the middle of March either. The
collapse of a prominent Wall Street institution as well-known as Bear Stearns
had been a reliable sign of a market bottom, as it was after the last four big
Wall Street collapses (Continental-Illinois in 1984; Drexel-Burnham Lambert in
1990; Kidder Peabody in 1994; and LTCM in 1998). Market technicians also pointed
out that the S&P 500 not only gained more than 3% for two days in a single week
in mid-March, but also that 90% of stocks were up on those days as well. The
last two times this happened within a space of a week was in July 2006 and
November 1987, and both occurrences were followed by long and sustained market
rallies. Finally, the Merrill Lynch survey showed the exact same thing in March
as it did last week: that fund managers were sitting on record high cash
positions and were as gloomy as they have been in a decade. Yet with the benefit
of hindsight, it turned out that all these predictions were wrong. Ply a Wall
Street or City of London analyst with enough booze, and he'll soon reveal that
he can generate an endless number of convincing indicators that in the past have
signaled the market will go in a certain direction -- but then do not pan out in
the future. That's also why it's so difficult to implement John Templeton's
advice to buy stocks at the point of "maximum pessimism" or the Rothschilds'
advice to "buy when there is blood in the streets." Market bottoms -- like
recessions -- only are confirmed with the benefit of 20/20 hindsight. With
thousands of market players, there inevitably will be a handful who get the
timing right. Rarely will they admit, however, that they owe their success to
dumb luck as much as savvy analysis. George Soros Turns Bullish: Mr. Spock's
Built-In Advantage As investors, we face two psychological challenges in calling
market bottoms. First, we all see what we want to see. Bulls will trot out
arguments for why the market is turning; bears will be equally convincing in
arguing the exact opposite. Psychologists call this "confirmation bias" -- an
affliction from which there is no escape unless you're "Mr. Spock" from the
classic Star Trek TV series. Second, the relentless and painful head-fakes of
bear-market rallies start to feel like a non-stop, live version of "the boy who
cried wolf." By some measures, the market has survived no fewer than six
separate "market meltdown"-style scares the likes of the threatened Fannie
Mae/Freddie collapse during the last 12 months. It takes remarkable
psychological stamina not to join investors who just throw up their hands in
disgust, and become too exhausted to care. Again, Mr. Spock's emotionless Vulcan
approach would serve us best. Finally, as good as it is to outsource your
investment decisions, don't put too much faith in George Soros' call on India.
By the time you read this, Soros may already have changed his mind. Only in
January, George Soros declared the credit crunch "the worst market crisis in 60
years." Yet within a few months of predicting economic Armageddon, Soros is
putting his money to work in high-risk, emerging markets such as India. But
don't hold this against him. Soros considers this willingness to change his mind
as his single biggest strength as an investor. As he pointed out in an interview
many years ago: "The secret to my system is not that it allows me to be always
right. It is that it allows me to recognize when I am wrong." And the taste of
that medicine is often too bitter for most investors, whether they are bulls or
bears, to swallow.