RELATED TOPICS -->Timing Systems to avoid Bear markets |
                               | Importance of stock market Cycles |
                               | What is actually happening during the crash |
                               | Timing the trough (bottom) of the crash reliably  |
                               | What shares to buy immediately after the market recovers |
                               | Using PeakFinder for reliable signs of being at a market top |

Our first lesson is an important one. You need to understand that the current bear market is normal. In fact it is welcomed for the wily investor. To quote Warren Buffet "Be scared when everyone is greedy and be greedy when everyone is scared". Now think of this - the US markets have seen their greatest drops since the great depression and Buffet has started buying American stocks!

This paper will take you through some of the history and nature of previous JSE crashes, what causes bull and bear markets and then shows you why now is an absolutely fantastic time to be investing in the stock markets for the long run. We even show you how to make money DURING a crash using simple mechanical strategies. You won't see any of this type of research for the JSE published in South Africa.

BACKGROUND
Look at the table below of 11 significant downturns on the JSE over the last 21 years, viewed from a peak-to-trough perspective.

 

There have been many more "mini downturns" but the ones above are the "grown-up" downturns. Grown up downturns we defined as lasting longer than 90 days and representing a decline of more than 15%. The periods above are the only times this has happened since Oct 1987. Each time the market bottoms-out, it has risen to higher than all the periods before! Each time the market turns after the trough, there are incredible gains within short periods of time. These are normal cycles that flush the system, as contrary to popular belief the markets are not that efficient. Markets price things too high due to over-exuberance, which leads to collapses eventually happening due to external events such as a financial crises and then the subsequent collapses go completely overboard in the ensuing panic and sell-off. All the investment greats recognised bear markets as golden opportunities for buying stocks for far less than they are worth and then selling them for far more than they are worth. How else do you think these men made billions of dollars?

Another interesting point is how quickly major downturns have rebounded. The below table shows the same periods as above but from a trough-to-peak perspective. Note how much longer these "bull runs" are than the downturns (DAYS column.) Note how quickly the reversals gain ground within 6 months of the trough. These are just for the ALSH index and chances are if you had picked some blue-chips during the upturn you would have gained even more (in fact we have proved this theory in our Anatomy of a Crash paper).



Back to the first table above - you will note that we were 182 days into the last downturn and the JSE ALSH was a record 46.4% down, although not too far off the Oct 1987 and April 1998 protracted bear markets (although slightly longer). The current rebound has been breathtaking and if the other major corrections/rebounds are anything to go by, we have just started.

This looks like the time to pack our rifles and doing some value hunting! But before we willy-nilly buy any old stocks we need to take you through a few more lessons based on our research of the last 12 months.


You can click on the above diagram for a more detailed view of the all-share index in the last 20 years. Note how short the "crashes" are (no more than a year but mostly less than 120 days) and how long some of the "bull runs" can be (2, 3 even 5 years!). Also note how each bull run more than makes up for the losses of the previous "bear run". Also note that as we move to the right each correction seems "deeper"misleading you into thinking the corrections are getting worse and worse but in reality as you can see from the % figures, they are all more or less the same (20-45%). This is merely an optical illusion since each correction is off a much higher base.

FIVE PHASES OF THE STOCK MARKET CYCLE
From trough to peak, the stock market goes through five distinct phases, namely Accumulation (when the early adopters, value investors and "those in the know" get in), Mark-Up (early majority), Greed (late majority), Distribution (laggards) and finally culminating in Mark-Down (desperate). It is always important for the investor to understand which phase we are in as it impacts your investing style, returns and risk. Our SuperModel market timing dashboard tracks the JSE through each of these phases. You can read more about these phases over HERE.

RECOVERY OVER-ESTIMATION
One mistake investors make is over-estimating the extent of a % correction. The flawed logic goes like this :"In the 2008 crash the market fell 46.4%, but as at 20 May 2009 it grew 26.4% since the trough so it has regained just over half its losses." This mistake costs investors dearly as they don't feel there is enough "value" or "margin of safety" left in the market for them to make a punt. We can guarantee you that many investors think they are too late and have missed the current rebound. But consider this - to regain a 46.4% drop, you have to grow again by 86.6%. Work it out yourself - R1.00 less 46.4% equals R0.54. Add 86.6% to R0.54 gets you back to... R1.00! In fact, as at 20 May 2009, even after the 26.4% rebound, the ALSH has to grow another 48% to reach its previous peak from which it fell! Maybe it's not too late to get back in then!

P/E AND D/Y DURING BULL AND BEAR MARKETS
Undoubtedly, the last bull run has been remarkable and it is with a sigh of relief that sanity prevailed and we have a long overdue correction. The current correction is the biggest in 21 years at 46% but it has only retraced 2 years of growth (to June 2006).  We cannot say how long stocks will languish at these levels, nor how quickly they will rise again, but this is academic to the value long term investor. The idea is to get in when solid stocks are cheap and let capital growth, dividends and time in the market take care of the rest (time in the market is more important than timing, but even now the timing looks good, even if the market still goes down another 15%). Look at the below chart to see why now is such a special time for the long term investor:



The last 15 years of the ALSH are shown together with P/E and Dividend Yield (DY) of the ALSH index. Markets cycle between PE compression and PE Expansion. When PE declines whilst the market declines we have a "bear market". When PE declines while markets are sideways or rise modestly (depicted by "PE Compression") we have a "range-bound market". When PE rises we have a "bull market". 

Contrary to popular belief, research has shown that low PE and high DY tipping points coupled with lowering interest rates trigger bull markets and NOT the economy. See how historically low PE troughs and high DY peaks preceded the last two bull markets in the picture above. Look at the historically high DY and low PE we sit with now. We may never see the incredible bull run of the last 5 years again, more likely we will see a slower more cautious and sane ride back to the top. The main point is that by getting a portfolio of the right shares together when PE's and DY's are at historical lows and highs (such as right now!) you will still be set to reap more than satisfactory returns that will outperform most of the market.

THE INTEREST RATE AND MARKET CYCLES
Stock markets lead the economy by 6-12 months. They dip before the economy dips and they rise before the economy recovers. Trying to assess the state of the economy to predict stock market cycles is not only difficult but not very useful as the stock market is a leading indicator for the economy and not the other way around. On the other hand, interest rate cycles provide important clues to stock market direction. Generally speaking periods of falling interest rates give rising stock markets.

In his famous book, "Winning on Wall Street" Martin Zweig (we cover his strategies here) tested a simple mechanical stock picking strategy of buying the S&P500 when interest rates dropped and switching to bonds when interest rates rose, from 1954 to 1996. This strategy delivered an annualised return of 15.5% versus the S&P500 buy-and-hold's 7.9%. The interest rate cycles delivered correct timing signals a stunning 81.8% of the time! Zweig used this market timing strategy together with his mechanical stock picking strategies to become one of the most successful modern day investors.

We did a similar Market Timing exercise over the last 12 years on the JSE below (we are trying to obtain longer term historical Prime-Rate data and when we do we will redo this exercise over a much longer term.)



The shaded blue areas indicate times to be in the share market and thus their left borders signify BUY signals and their right borders signify SELL signals (when interest rates started their rise.) Ignore the orange lines/arrows as we cover these later in an improved strategy. During high interest rate periods (the unshaded areas) we have our money earning interest in a bank account. During declining interest rate periods we have our money in the stock market.

Using this method versus a buy-and-hold JSE:ALSH or "money in the bank" strategy showed remarkably superior returns (let alone far less risk as you are kept out of the bear markets!) The chart below shows the returns achieved for each period under review. For the "banked" periods we calculated the average daily prime rate minus 3 on a monthly basis to estimate interest earned, but in real life or in the money markets you will probably be able to do even better than this.



It is notable that the "timed" strategy convincingly outperformed the ALSI buy and hold method even though it has a tendency to "bail-out" of the bull runs prematurely. We cover an improved version of the timed strategy in more detail under the Zweig strategies section to minimise the extent of this prematurity, but the main point we wish to make is that you can expect (as in the tests Zweig did on the S&P500) to almost double the returns of the market index for far less market exposure risk. Of more importance, you need to note that a BUY signal was generated on 19 December 2008 (interest rates started dropping) and we are on an extended period of interest rate declines of at least another 8-12 months, which, according to this theory and history, is bound to drive stock market returns higher.

USES OF MARKET TIMING
Although we used the "market timing" theory above for a simple, but highly successful mechanical investing strategy, it also has uses for all the other strategies we cover on our web site. Simply put, you must make sure the JSE is in the "blue zone" (ie in a falling interest rate environment) before investing in the stock markets. Zweig used market timing as his first criterion for investing before he moved onto his other check-lists such as low P/E, earnings growth etc. His theory was that you don't go "against the flow" and only invest when the general trends are "on the up" and the odds stacked in your favour.

We cover several highly effective market timing systems, culminating in our famous SUPERModel Composite Market Timing System that delivered 117,000 growth versus a JSE buy-and-hold strategies 8,500% growth over the last 31 years, by only being vested in the JSE 47% of the time!

OTHER FACTORS EFFECTING STOCK MARKETS
Besides local interest rates,historical PE, DY yields and the PE expansion/compression effects we have discussed, there are other factors such as the economy, inflation, exchange rates and international interest rates that also effect stock market cycles and expected returns as depicted below. Right now, we are on a course for a period of "Above Average Performance" for the JSE, as ALL the factors below are in a "perfect 7/7"




CONCLUSION : SUCCESS ON THE JSE FROM PAST LESSONS
International research is very clear and very consistent, and here at PowerStocks Research, we have validated these trends on the JSE. The biggest factors that contribute to your wealth and overall probability of success on the stock markets, which you can control, are, in order of importance:

1. Your Market Entry/Exit TIMING ("go with the flow")
2. The initial valuation dictated by the PRICE you pay, and
3. The TIME you hold your investment for in the market.

We have discussed market timing in the previous paragraph and it is clear the timing for investing seems to given the "all clear."

To see what a massive impact initial PRICE has on your ultimate returns in the market, see our research paper : The Power Of Value. Stock market crashes compound this power, since prices fall sharply. In fact, they compound the effect of PRICE so much that you can derive a stock picking strategy that can achieve incredible gains during a crash. See our ground-breaking research titled "Anatomy of a Crash" that shows you how to do this.

To see just how "low-risk" an investment in the JSE has been over the last 50 years, and what a massive impact TIME in the market has on lowering your risks and raising your returns, see our ground-breaking research titled "Probabilities of winning on the JSE"

Finally, this site is all about proven STRATEGIES that maximise returns and lower your risks. See our flagship designer investment strategy PowerShares and BLUECHIP that were developed specifically for the JSE. All our strategies are internationally recognised and then backtested on the JSE to ascertain and confirm relevance. We then run live model portfolios of these strategies to monitor their performance in real time ("Paper Trading") We maintain various strategies that are tailored to specific gains and risk objectives of the JSE investor. To see which are our best performing live "model portfolio" strategies for 2009, go and see the Strategy Scoreboard.

RELATED TOPICS -->Timing Systems to avoid Bear markets |
                               | Importance of stock market Cycles |
                               | What is actually happening during the crash |
                               | Timing the trough (bottom) of the crash reliably  |
                               | What shares to buy immediately after the market recovers |
                               | Using PeakFinder for reliable signs of being at a market top |
 
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