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Profiting From Excessive Market Movements

By February 8, 2013March 1st, 2022featured articles

The GillenMarkets online investment newsletter is mostly about sound investing – identifying value, understanding that volatility is normal and is not the same as risk, and that patience is also a key ingredient to investment success.

In a slight deviation from normal preachings, I am going to outline two recent examples of a market going to excess – one to the downside and the other to the upside and how an investor might ‘trade’ these opportunities short-term.

I will also highlighting the tools we use to highlight these excesses, and the advice we provide to subscribers on how to understand when a market may have overshot on the upside or downside and how to take advantage of it.

The first example is of the frenzied sell-off in the Eurozone equity markets that occurred in July/August 2011, as investors’ fears escalated regarding the likely impact of the developing Eurozone sovereign debt crisis.

The first chart shows the progress of the Euro Stoxx 50 Index along with its 30-week moving average. The moving average provides a guide as to the underlying trend in the market. Notice how, in August 2011, the index had fallen 23% below the 30-week moving average. This is a measure of the speed of decline.

In the next chart, we plot the percentage that the Euro Stoxx 50 Index has deviated from its 30-week moving average all the way back to 1970, both above the 30-week moving average and below it. This provides us with 42 years of useful data. And what we find is extremely instructive. Since 1970, there has been perhaps just 7-8 occasions where the index declined so rapidly that it deviated by 20% or more from its underlying trend – the 30-week moving average.

With this information, the GillenMarkets website advised subscribers in mid-August 2011 that the Eurozone markets were a ‘Buy’, not a sell. Many investment commentators were arguing the opposite. But the stock markets are discounting mechanisms – they discount the developments of the day. And in August 2011 investors had sold so furiously that the probability was high that Eurozone sovereign debt crisis had been priced in at that stage. If it was priced in, then the odds strongly suggested that markets had only one way to go, up.

Our analysis told us that in Agust 2011 a rare ‘Capitulation’ event had occurred and that the selling was indeed already done, in which case the most likely outcome was recovery. We suggested two funds to buy to take advantage of any recover – the iShares DJ Euro Select Dividend 30 ETF (which is up 15% since) and the Fidelity European Values Fund (which is up 45% since).

That’s history so are there any such trends evident today? Well yes, the Japanese equity market has gone on a tear since November 2012 as a change of government and change in policies has lead investors to buy into what could be the start of a genuine long-term bull market in Japan (following a 23-year bear market).

The third chart highlights that the Nikkei Index, following a strong rally, is now almost 20% ahead of the underlying trend of the market as defined by the 30-week moving average. This tells us about the pace of the ascent.

The next chart above measures the percentage that the Nikkei Index has been above or below its 30-week moving average since 1959. And it is clear that the index has rallied 20% above the underlying trend on only 6-7 occasions in the last 60 years. That’s useful information.

Remember, investors go to extremes when everyone agrees with each other. In this case, investors are optimistic that the Nikkei is headed higher. Of course, they may well be right in the medium- to long-term. What our data tells us is that the Japanese stock market may have risen to fast in the near-term, and that the odds favour a correction here.

The current advice to subscribers on the GillenMarkets website is to hold off investing in Japan until a correction occurs. We can’t be sure a correction will occur as, like all mortals, we can’t see the future. But history tells us there may be a better entry point presented in the weeks ahead. We shall see!

The GillenMarkets approach is investing; we eschew trading or speculating on the basis that most private investors will lose money that way. Ours is a subscription-based website where you pay us for our research and views. In that way, we are firmly on the same side of the table as you.

Timing the markets as in the above examples is not the core of our approach or offering. Nonetheless, psychological factors drive markets to excess leading, at times, to huge volatility. With our aid, you can not only understand this volatility for what it is – human emotions on display – but you can learn how to go against the crowd at critical moments rather than succumb to the markets’ folly.

These Free newsletters are part of our marketing. We hope you enjoy them, but we also hope that at some stage you’ll consider joining our growing list of subscribers.

We offer a 14-Day Free Trial to the website, which gives you access to the whole website for two weeks, and to two weekly bulletins from myself – published on a Saturday.

GillenMarkets is the only website of its kind in Ireland, and there are but a handful in the UK. We are dedicated to uncovering value in markets and to ensuring you have a plan to follow. This distinguishes us from stockbrokers, banks and insurance product sales people.