We have an index of phone calls at Orpheus. This is an internal sentiment index that we use. The more the calls we receive in a certain week, the stronger the market sentiment. The week that went started with frantic calls regarding the market volatility. “I am long on the market after markets fell 10%, but they don’t seem to stop falling, and now DOW is down too, what should I do?” Another query was, “When will this fall stop. How low can it go?” Another one involved Fannie Mae, Freddie Mac, and Merrill. “What was their future?” Another was regarding the short-selling ban and how will it modify market behavior? “What else will the regulator do? Open interest has increased in the market, what does it mean? I am still in doubt regarding the bottom. Does doubt about a bottom make it a better bottom?” Of course, once in a while, we also have the regular confessions regarding leverage and need for vacations and detachment. Markets do take a toll on the human psyche and more the emotional maturity better it gets for the investor, trader or speculator.
On the first impression, the frantic call index spiking near panic lows, or capitulation bottoms might look like a strange phenomenon. But a deeper thought and you can start seeing a cycle. We at Orpheus consciously monitor market sentiment. The need to understand sentiment is so strong that whenever we conduct a conference with more than 50-100 people, we do a survey. We did one in Dec 2006, weeks before Romania was to enter the European Union. I raised my hand and asked the large group, how many think markets will become half from here. Not even one hand rose. Jan 2007 saw a collapse of 30% after Romanians celebrated the EU entry and went across the Hungarian border to have coffee without being asked for visa or passport details.
On another occasion in 2007, the same question saw another hand-raised along with mine. This time, it was head research of an Institutional brokerage company. But we were still in a minority, two loners who believed markets can halve in value. Market sentiment is like this, lonely at tops and overwhelming at bottoms. Tops we are kings and bottoms scared prisoners of war, searching for survival trenches to hide in. Capitulations are chaotic while euphoric up moves are celebrations. Tops are when we celebrate and dine with our broker and bottoms are when we fire and sue him. This is the reason the frantic call sentiment Index never spikes at a market top. It is only after markets start falling that the bells start ringing. This is human nature. We pay more for Put options in a market collapse than we pay for calls in a euphoric rise. Fear remains a stronger motivator than greed.
This is why capitulations can be measured easily compared to euphoric tops. There are also more signals near a bottom than there are exhaustion signs at a top. Above this price, rockets can push up higher, but the market has a limit to where it can fall to, 50%, 60%, 90% are clear limits on the downside. But the upside is technically unlimited, till the moon. There are of course other problems linked with capitulations. Even if we hit or identify a capitulation bottom, prices take more time to rise than to fall. We take more time to build than we take to destroy. We move from margin lending schemes at market tops to banning short sales at lows. There is a complete history of short sale bans and revokes.
The proponents of globalization have also contributed to this capitulation. They just made it global. There are cycles of liberalization and protectionism. We open up and build walls cyclically. Globalization brought free trade, economic growth, and consumerism. Along with all this came speculation and global capitulation where contagions happen together around the world. We talked about one such impending capitulation in The October low. Global contagion and capitulation have group power. When many countries fall at the same time, it creates a stronger sentiment than what a single market collapse would have evoked. Group power hence has more signal power. If we have 10 sectors in the market and all of them are in gear, that’s just the turnaround signal one needs, everything falling and negative at the same time. What happened now was a global contagion. Year to date, Russia is down 50%, Shanghai Composite is down 60%, Brazil BVSP and Indian Sensex are down 30%. And along with this, if you hear about bankruptcies and bailouts, the panic is bound to be global.
Capitulation cycles can also be linked with simplicity cycles. Markets wake up and ask, “Why we made it all so complex?” There is a strong need to simplify things again. The need for affiliation increases and the need for achievement decreases. It is a clear move from the conscious to the subconscious, and introspection. Market knowledge also moves from short-term to long-term memory. The bigger the crisis, the deeper it gets into market memory. Capitulation is like grieving and mourning. It is a five-stage process, anger, and intense emotion, denial, guilt, depression, and sorrow and finally acceptance.
Sentiment in terms of news also reaches historic proportions when the market hits capitulation lows. The bulls thank the Federal Reserve while the bears blame and curse the bailouts. We are in historic times and such a high number of capitulations for us may make the stock study redundant, but as a panic extreme, such extreme sentiments still favors potential impending bottoms rather than continued precipitating declines. We need to look at time cycles more to understand whether the capitulation low happened already or is it coming in October? A smarter investor, on the other hand, would wonder “What Capitulation?” His green stocks like Vestas Wind, ITT Corp, First Solar are still positive for the year.