***Bulls – bears – George Soros cares!

From Gareth Stokes, MoneyWeek editor, SA

Dear MoneyMorning reader

There’s a tried-and-tested value investor motto that rings: Bulls – bears – who cares!” Students of this school of investing make their purchases for life, so they’re not overly concerned with the direction in which markets trend. That they make more purchases during market downturns is purely coincidental. They end up investing against the herd because nothing exposes value better than recession! In stark contrast modern day investors – or should we call them speculators – obsess with timing their market entry. Hours are spent on technical charts in a vain bid to find the perfect moment to act on fundamental assessments. So who’s right? Can we really ignore market direction when buying shares?

If you’re paying close attention to this debate you’re probably already objecting. “The trend is your friend,” you scream! And that means you should sell during bear markets and buy when the bull market makes a return. But hold on. This expression simply tells us that the trend is our friend… What our friend tells us depends entirely on our relationship with the market. If we’re value investors the bear market trend nudges us to really ‘bombed out’ value plays. If we prefer investing for growth and momentum, the same trend will be urging us to stay out! Our biggest problem is identifying trends during periods of extreme market volatility. Is the 30% plus bounce we’ve seen on Wall Street, in the UK and on the JSE a reversal of the bear trend – or are we witnessing what analysts call a ‘dead cat bounce’ or ‘bear market rally’.

Respected investor George Soros is quick with his answer. He says “it’s a bear market rally because we have not yet turned the economy around.” In his view the market cannot enter bull territory until the world exits recession. “This isn’t a financial crisis like all the other financial crises that we’ve experienced in our lifetime,” says Soros. The world’s greatest value investor, Warren Buffett, partially agrees. He observes that the US economy has “fallen off a cliff!” And he acknowledges that the economy could get worse before it gets better.

But he doesn’t draw a conclusive link between economic and market performance. In his 2008 letter to Berkshire Hathaway shareholders, Buffett concludes: “We’re certain that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall!” Buffett accepts that markets can recover while the real economy struggles and vice versa. And he further illustrates this point by summarising the performance on the S&P 500 over the last 44 years. Over that time the index posted gains 75% of the time. “A roughly similar percentage of years will be positive in the next 44; but neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance!

What can we learn from what Business Day markets editor Stephen Gunnion calls “the chorus of sorrow?” Perhaps the bottom line is that even the experts disagree on what constitutes a market recovery. Soros reckons we’re in the middle of a bear market rally because the global economy is in tatters while Buffet claims the market could bounce even if economic conditions remain sketchy. Perhaps we can take heart from Garth McKenzie of BoE Private Clients who says “every bull market starts with a bear market rally!” He warns, however, that markets will probably move sideways for the next year or two. And it seems volatility is the only certainty!