In investing, opportunities arise when perception and reality diverge. Hence, it is important to understand not only reality but perception as well.
This is a difficult concept to understand but, in my opinion, is the key to superior performance.
If history is any guide, a big scary event like the demise of Bear Stearns is often a signal of a bottom for the broad market. There have been four failures of a major financial institution over the past 25 years. And stocks have been higher six and 12 months later in each case.
– “Hitting Bottom? Several Banks and Brokerages Are Ready to Pop Up for Air” (subscription required), Jacqueline Doherty, Barron’s, Saturday March 22
A crisis builds up over an extended period of time. It ultimately reaches a crescendo when an event occurs that is so devastating that even the staunchest skeptics become fearful. At this point, the government and participants in the impacted sector get together and start to take actions that will ameliorate the crisis.
In the current crisis, the triggering event was clearly the insolvency of Bear Stearns.
– “The Financial Crisis Is Over” (subscription required), Dick Bove, Financials Analyst, Punk Ziegel, Thursday March 20, 2008
On that score, a notable shift in perception has taken place over the last few days.
I believe it started with Dick Bove’s “The Financial Crisis Is Over” which was the talk of the market on Thursday.
Barron’s cover on Saturday was titled “Have The Banks Finally Hit Bottom?” (Barron’s Cover)
A number of others have also jumped on board and called a bottom.
The key argument appears to be that crises come to an end with a cataclysmic event: the failure of Drexel Burnham Lambert, the junk bond shop, in 1990, the collapse of Long Term Capital Management in 1998 and, this time, the implosion of Bear Stearns.
Every single bottom caller I’ve read makes the same argument: the implosion of a major financial institution, Bear Stearns in this case, marks the bottom.
Has this always been the case historically? How good is this argument? Those are the questions you want to be asking.
Along the same lines, stocks and sectors you’d expect to see move off the bottom are moving today:
- Google, Apple and Research In Motion are having their best days in quite some time
- The homebuilders are breaking out
- Consumer Discretionary stocks (XLY) are vastly outperforming Consumer Staples (XLP): +3.50% vs. +1.00%
If the bottom callers are right, this represents a buying opportunity. If they are wrong, it represents an opportunity to sell stocks and possibly look for entry points on the short side.
Either way, these kinds of sentiment shifts represent opportunities I’m always on the lookout for.