Global Agenda: Here and there

The iron rule of markets is that all trends come to an end, eventually changing direction.

By PINCHAS LANDAU
November 20, 2005 06:52
4 minute read.

The iron rule of markets is that all trends come to an end, eventually changing direction. However, an adjunct of that rule is that trends generally persist longer than seemed likely beforehand. The better-established the trend, the longer it is likely to carry on. This is the source of one of the favorite sayings of traders - "The trend is your friend". True, eventually, this 'friend' will do the dirty on you, but most of the time, the existing trend can be expected to extend into the future. When the trend in question takes the form of a prolonged boom or bust, the tendency and temptation to expect a reversal becomes greater the longer and stronger the trend waxes. This often results in painful miscalculations on the part of those investors who try to outsmart the market. "This market is crazy," is their starting point. "Prices are way out of line (too high or too low), so the smart thing to do is to go in the opposite direction to the market." All too frequently, the result is a squashed investor, as the market roars onwards in the direction it was going. Eventually, somewhere down the road, the crash or reversal takes place, but this has come far too late for the would-be market beater. From an investment standpoint, in those cases where you are convinced that the market is wrong, the optimal approach is to step aside rather than to try and swim against the tide. The stronger the current the more useful this approach, because in those cases where the market becomes caught in a speculative mania there is little point in being the only sane person in the madhouse - they'll kill you anyway. Just remove yourself completely from the scene until sanity is restored. These general rules are valid in all markets, whether for shares, orange juice, or condominiums. The history and study of market manias extends from tulips (in 17th century Amsterdam) to Internet dot-coms (in late 20th century New Amsterdam, er sorry, New York), but the key features are always the same. Thus, the idea that the housing market in the US today is undergoing a mania-type boom has been widely discussed over the last two years - including in this column. However, even those who believe that the market is not in the grip of a mania will agree that the strong uptrend in prices will eventually change direction. The key issue is not only when that might happen, but whether the new direction will be roughly sideways or slightly downwards (as happened in Australia and the UK over the last year or so), or sharply and painfully downwards, i.e. a crash. Interestingly, prolonged booms attract much more attention and analysis than do prolonged slumps. There are various possible explanations for this phenomenon, most having more to do with psychology than with finance. The simplest one is that in a prolonged slump less and less activity takes place. It's hard to get worked up about what's not happening, but easy to get excited about hyperactivity. However, even if slumps are boring, they represent much greater opportunities to investors than do booms. Most great fortunes are made by patient work conducted during prolonged slumps with the seeds sown then blossoming when the market changes direction. The Israeli residential housing market is in its tenth straight year of decline - a rare and remarkable development in its own right. In line with the "iron rule," we can be sure that this market will eventually turn up. But we can't know when. Indeed, most everyone in this market has given up trying to figure out when, since so many apparent reversals proved to be false. However, on a purely statistical basis, the longer it goes on, the greater the chances that the slump will soon end - 10-year slumps are extremely unusual. There are currently several indications that the Israeli slump is in the process of ending. Perhaps the most persuasive of these is that a number of Israeli real-estate tycoons, who have made big money in recent years investing overseas, have cut back their foreign operations and are bringing their money back home. At the same time, there are growing indications that the American boom is over the top - for instance, an all-time high in the inventory of new homes available as builders fall over themselves to supply the seemingly insatiable demand. Rarely do trends cross so obviously, but when it happens, you don't need to be a tycoon or a genius to see where the wind is blowing. landaup@netvision.net.il


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