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"What should I buy?"

What should I buy?

When markets rip around, a lot of old friends and acquaintances pop up. After polite inquiries about family there’s normally a warm up question (how about these markets eh?) before the real question. At the moment it takes one of two forms. “Is it time to buy?” or “What should I buy?”

It seems we’re always fighting the last market battle. Many investors remember the strength of the bull that drove shares higher for ten-years. Those who bought shares almost any time after March 2009 did well. Many profited from a “buy the dip” mentality. Despite the very clear evidence of an enormous change in market conditions, many are still clinging to this behaviour.

It’s true that at some stage in the future there will be a share market bottom. Investors who deploy cash at the bottom could reap rewards for years or decades to come. However there are many signs that share markets are not yet at those levels.

Markets are described with numbers. This sometimes fools us into thinking that markets are somewhat mathematical, logical or scientific. Yet the man considered the founder of modern economics, John Keynes, is often quoted; “Markets can remain irrational longer than you or I can remain solvent”.

Keynes spoke from bitter experience. He was bankrupted twice by an unruly stock market. Economics, company fundamentals, government policy and international relations are all factors that affect share prices. Yet a full grip on all of these factors is not enough to predict market moves. Instead, market prices are the product of crowd behaviour. Ultimately, a market rises if there are more buyers, falls if there are more sellers.

It doesn’t matter if the buyers and sellers are acting rationally. Their weight will move the price. The way a price moves reflects the crowd behaviour, and more can be gleaned than simply whether buyers or sellers are in control. The way a market moves – the size and speed of movement, and the accompanying volumes, give clues about the way the market crowd is thinking.

The wild stock swings and huge volumes that characterise recent market activity indicate widespread uncertainty. The oversized falls and rallies occur as the balance between buyers and sellers shifts. In other words, the market is changing its mind regularly, and with vehemence.

Investors may have taken comfort from some of the supersized one-day gains, but the fact remains that a 10% lift in a single session is just as concerning as a 5% fall.

One clear sign that stocks are finding a low point is a return of more normal trading conditions. Daily ranges will shrink, day-to-day changes will be more moderate, and volumes will decline. It’s possible that this kind of stabilisation will occur after a spike low, so investors waiting for a signal from more usual trading behaviour could miss out on the first 5-10% of any recovery. Some may see this as a small price to avoid buying in the maelstrom and suffering significant further falls.

Those who were around may remember the atmosphere in March 2009. The previous year was full of false starts, and false hope. Stocks would appear to form a base, then start rising – only to drop sharply again on more bad news. Central banks had reversed their tightening and had slashed interest rates to near zero, and it wasn’t helping.

Even investors who’d cashed up before the GFC crash, and waited a year before buying back in, were underwater. Long only investors that wore a 30% initial GFC loss watched in horror as those losses doubled in the last quarter of 2008 and the first months of 2009.

Many gave up, and sold their stock holdings. Some never bought another share. In hindsight this was the final capitulation, the slide into despair, and the sign to buy. It’s easy to imagine that the strongest bull market in modern history could give rise to the most ferocious bear, and it won’t be time to buy until we again see and hear despair.

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