March Madness – The Risk in Being Early


Equity markets have rallied 9% in March 2009.

The risk of jumping into markets too-early could outweigh the risk of being too-late.

Expect increased frequency of large one-day market upswings but be cautious to assume the end of the bear-market has passed.

We have been participating in the rallies for our clients.







 Anyone following stock or credit markets is likely relieved to see the first positive market performance in quite some time.  In fact, March 2009 has brought forth a 9% rally in both Canadian and US equity markets. We have been personally participating in the rally on behalf of our clients and are pleased with the results so far.  However, the question on everyone’s mind now becomes, “is this the end”?


Before looking at this question directly it is wise to remind ourselves that as recently as a month ago the equity markets continued to grind downwards.  Many market participants were looking to sell-and-run if they had not already done so.  How worn out was the everyday investor?  Mutual fund redemptions in Canada hit record levels in the fall and finished 2008 with four straight months of net redemptions.  Although, the first two months of 2009 have shown a net increase of investors putting their money into mutual funds, this inflow was the weakest that has been seen in the last six years.   Added to this fact is that most of the mutual fund inflows have been into money-market funds as opposed to the relatively more risky equity (stock) funds.

With the recent positive March stock market returns comes thoughts of the possibility that the worst is over.  Those who have exited the stock markets now must face the possibility of being left behind by an upward trending market.  Despite the fact that the last year has left many feeling sick of the thought of plunging into stocks again, the thought of missing the opportunity of recouping losses in a historically “cheap” market is even more worrisome.  Adding to the confusion is the five, six, or even seven percent plus intraday price fluctuations of many large, otherwise stable, stocks.

To put this March into perspective we turn to the chart below of the S&P 500 over the last 139 years.  The first feature that comes to mind when looking at this chart is its symmetry.  With this feature in mind it is only natural to wonder that if 2008 was just an extreme year which hasn’t permanently maimed the financial system or the economy, then from simple mean-reversion (an extreme movement in one direction is usually followed by movements in the opposite direction) we could argue that the worst could very well be over.   Thus, the market reaction that we have experienced so far this March 2009 could be the forerunner to a “decent” year of returns.



The Risk in Being Early


 However, before making an emotional response and diving into the marketplace, it is best to note the following observations which have been typical of many “bear markets” in the past.

The chart below of the MSCI World Index demonstrates the risk of being too early in calling the bottom of a market.  On average, entering the market place four months before an eventual market bottom (which unfortunately can only be precisely pinpointed after the fact) resulted in an average loss of 22%.  On the other hand, missing the market bottom by being four months late resulted in missing a relatively small 8% upside.  This does not mean that sitting and waiting is the best course of action, but the exuberance brought on with a little positive market news could very easily be countered if equity markets retest their lows later this year. 



Source: Merrill Lynch – March 16, 2009, “Global Quant Panorama”


 As for the tremendous upside volatility that we have been witnessing, it is an important reminder that “high return” single days, or days in which a market index makes gains of over 2%, is more common in bear rather than bull markets.  The following chart of the MSCI World Index over the last two decades demonstrates this.   During the most recent down trend +2% return days occurred approximately once every 16 trading days.  However, observing days of similar magnitude occurred almost 10 times less frequently in the most recent bull market.

 In summary, daily fluctuations will indeed make investors anxious to enter the market.  However, these fluctuations aren’t necessarily the signs of an upward trending market.





Source: Merrill Lynch – March 16, 2009, “Global Quant Panorama”


 The preceding entries contained above are intended for general educational purposes only and should not be construed as financial advice nor is this information intended to replace the advice of a licensed financial advisor.  All readers are encouraged to review their personal financial situations and needs with a licensed financial advisor prior to making any investment decision.  Although efforts have been made to validate the information presented in the above entry, Pacifica Partners Inc. can accept no responsibility or liability as to the completeness or accuracy of the information contained above. Any opinions reflected above are subject to change without notice.

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