Panic Driven Sector Rotation

by: Max Wolff April 02, 2008 | about stocks: DBA / EEM / GLD / IYF / IYM    

Max Fraad Wolff

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

In a dark room panic easily sets in. The more people there are in the room panicking, the more likely a dominant trend of panic is going to emerge. False trends create wild movements away from the last "exit". Thus, the crowd surges and retreats until fatigue, hopelessness and success cull the herd.

Markets are crowded. Visibility is low. Faith in correction rescue ebbs and flows. Confidence in regulatory relief produces brilliant flashes of light. Long lulls and underwhelming results generate periods of darkness. All we know for sure is that we have to escape. The old lights will not be coming back to burn bright. Change is the only sure thing. No matter what you think you see, clarity is in short supply. The risk of stampede is very real.

Where is the exit from loss and the entrance to gain? It is very hard to know in a dark space full of panicked people. Sentiment can turn on a dime, or any shiny speck on the ground misidentified as a dime. Regulatory policy has added a strobe light to dark writeoffs and recession. Flashes of light emerge and are swallowed by darkness. Glimpses are offered but strobe lights produce distorted images. Flashes of light temporarily change the direction of the herd. Many run toward the light, some away from the light. Some days the light attracts, some days it repels. Neither strategy has thus far yielded escape. Short and long euphoria are quickly trampled by the horde, or rerouted by busts of policy light.

Darkness and undulating herd movements defined 1Q'2008. Rumors swirled, assumptions proved false and the Fed ran its strobe brighter and longer than ever before. Whispers of bailout, bankruptcy and fire kept everyone on edge and ready to run. Momentum proved easy to generate but hard to control or sustain. Nerves are so frayed that consistent crowd direction proves elusive.

A glimpse at the highly correlated flights back and forth between basic materials (IYM) and gold (GLD) for protection and financials (IYF), soft commodities (DBA), US markets [S&P500] (SPY), and emerging markets (EEM) reveal an oscillation between running left and running right. The chart below suggests a repeat pattern in this panicked crowd. Ultimately, one direction will prove to be the real exit and the other a trap.

click to enlarge

Disclosure: Long

Related Articles

This article has 9 comments:

  •  
    Apr 02 08:23 AM
    what are you really saying here?
    Reply | Link to Comment
  •  
    Apr 02 08:34 AM
    Interesting way to put it. It's great to be able to sit at your computer and buy and sell stocks and commodities, but this ease probably contributes to the general churning and volatility. There needs to be some disincentive for rapid trading, but I don't know what that could be.
    Reply | Link to Comment
  •  
    Apr 02 09:05 AM
    Nice article ... full of illusion.
    I think the market is going to continue in panic mode,
    flitting hither and yon, in rapid succession, ultimately going nowhere.
    I'm going to continue doing what I have been doing,
    buying when everyone else is selling, selling when everyone else is buying,
    each time picking up a few cents for myself.
    Reply | Link to Comment
  •  
    Apr 02 09:22 AM
    Excellent commentary! Someone who can actually use metaphors to capture the swings in this market! Back in December/January I decided to re-allocate based on a slowing economy. I haven't budged from my initial plan, and have watched from the sidelines. Quite a show indeed!
    Reply | Link to Comment
  •  
    Apr 02 11:49 AM
    the only real thing is that most of your
    capital is not where you believe it is:

    not just in the US:
    March 31
    Fiscal Year 2007: Capital/Assets
    US
    Bear Stearns 3,0%
    Morgan Stanley 3,0%
    Merril Lynch 3,1%
    Lehman 3,3%
    Goldman Sachs 4,5%
    Citigroup 5,2%
    JP Morgan 7,9%
    Wells Fargo 8,3%
    Bank of America 8,6%
    Wachovia 10,2%

    but also in:
    Europe
    UBS 1,9%
    Barclays 2,6%
    Commerzbank 2,6%
    BNP Paribas 3,5%
    Credit Suisse 4,4%
    Royal B Scotland 4,8%
    BBVA 5,6%
    HSBC 5,8%
    Santander 6,3%
    Reply | Link to Comment
  •  
    Apr 02 12:16 PM
    The disincentive for rapid trading will come as their bank accounts shrink, and shrink, and shrink...
    Reply | Link to Comment
  •  
    Apr 02 06:13 PM
    Anyone who uses the English language effectively must be prepared to hear "what are you really saying." Literacy is a dying art.
    Good description of raw mass emotion. Robert Johnson once called the currency markets a ship listing violently from one side to the other, with the ship's listing exacerbated by the crowd on the deck madly fleeing from one side to the other.

    Especially liked the brief--and false--dawns intermittently provided by the Fed. Until absolutely all the false dawn scenarios are exhausted, every upturn, especially in financials, will be a bear market sucker's rally. When we starting hearing the popular press braying helplessly and hopelessly for Bernanke's head and proclaiming the "death of equities" a la Business Week in 1979, the bottom will have been reached. Until then collect dividends from cheap hard assets like oil & gas income trusts and J-REITs or buy the companies that service those assets, like drillers, shippers, tankers and geophysics companies.
    Reply | Link to Comment
  •  
    Apr 03 03:11 AM
    Kaiser Karl IV - way back in time, in Europe - also called the wise emperor - did well.
    Trying to be wise how to invest today self earned money means also to be conservative - the money market does well for our children who are in the middle of their secondary education. Yes, in my opinion we are facing a though time in our so well connected financial world.
    Reply | Link to Comment
  •  
    Apr 07 02:55 AM
    Such correlation and a try to break out of it by spreading asset allocation across multiple non-tightly-correlated sectors and inverse funds is the method I'm using in my model portfolio at notiming.com/portfolio... . While trading such a portfolio is easy enough even given tax constraints such as wash-sales, the real question that comes up is what should trigger a re-optimization/re-bal... trade. I am still looking/testing various such trigger approaches, but would be interested to get your opinion.
    Reply | Link to Comment
More Comments on DBA »
Top Rated Comment Streams:

Numbers are net rating-

See all Top 100 »
More by Max Fraad Wolff

Investment Resources
Money Management
Research
Seeking Alpha provides these ads as a service to its leading contributors
Articles on related themes
Market Outlook
Asset Allocation with ETFs
Closed-End Funds
Commodity ETFs