Great traders and true value investors know that it’s not only the return function that dictat...
Ralph Bloch: A Sheperd's Advice
08/20/2004 12:00 am EST
For one of the most unabashedly honest—and humorous—speeches I’ve heard, we turn to Ralph Bloch, who began his career 48 years ago. The chief market technician for Raymond James was the first technician to call for a bear market in January 2000. Here’s his latest.
"As a technician, I want to analyze stocks from a pragmatic point of view. I was giving a talk once and a guy asked me what I thought about interest rates. I said, ‘I don’t think about interest rates. I do what technical analysis suggests. I let you think about interest rates and then I wait until you come to a conclusion—and when you do that, you either buy or sell.’ That’s when the technical analyst attempts to take over. We are trying to plot accumulation or distribution— more buying or more selling. I am not smart enough to figure out interest rates, the world of economics, all of that stuff. I can’t do it. I let all of you people do that and come to a conclusion.
"Why technical analysis? In March 2000, of all the stocks making new highs on Wall Street, just 1% were rated as sells. Now we’ve all found out what lying slime there are on Wall Street! All the new investors were coming in because the market was ‘easy.’ Where did they go? They went into the tech stocks. Most of them are still in the intensive care unit. I have seen many, many bubbles over the years. All of them have parabolic curves. As the stocks start rising, more people come in and the ascent steepens. This continues into a parabolic curve, which is what the NASDAQ did. A parabolic curve, ladies and gentlemen, leads to one thing every single time— a disaster.
"The decline off a parabolic curve very often is worse and faster than the rally itself. I did not trade during the end of the NASDAQ bubble. I felt like an idiot. I knew we were getting in trouble. Why? Because I drive a $50,000 car and my car was the cheapest one in the garage. Think about it. We had 25-year old kids in Porsches and Ferraris. I almost looked to buy a Ferrari. I must have been in a diabetic coma! Thank god I couldn’t fit in the car. My wife would have had me committed.
"Anyway, back to technical analysis. This is an attempt to X-out the noise level and just analyze what you people are doing. A healthy stock market, from my technical point of view, is very simple. It is an expanded version of Dow Theory. When the Dow industrials, NASDAQ, and advance-decline index—which is the most broadly based of all the measuring tools—are moving in concert with one another—all making new highs at roughly the same time—this is a very solid technical backdrop. The minute one of these indicators starts to diverge—or starts to lag from the others— it’s a red flag starting to wave. You’d better start getting nervous When there is a change in a well-established pattern of trading in the stock market it always means something, and you want to shift a little closer to the edge of the seat and be ready.
"I have conducted several studies asking, ‘If something changes, what and why did the change occur?’ I asked my research students to go back to 1929 and look at every time the Dow made a new high and the advance-decline index failed to confirm. There were roughly 15 times. There are very few absolutes on Wall Street. This is as close as it gets. Every one of those 15 times preceded a measurable sell off. When the Dow is making new highs, but fewer and fewer stocks are doing so, we have a recipe for disaster. The stock market can only continue to rally for just so long with stocks getting more and more narrow. So if you were aware of this sequence, you would have been out of the market prior to the 1987 top, the 1990 top, the 1998 severe sell off, and the top in 2000. I started to warn in late 1999 because breadth continued to get more and more narrow. And that continued for a long time. So there were 15 times going back to 1929 when a decline in breadth preceded a major sell off. You want to be aware of this, because its track record is incredibly important.
"Where are we now? This past February, the market had been coming off a very nice rally from 2003 led primarily by NASDAQ by the tech sector. The Dow made a new high in February, but the NASDAQ—for the first time in the rally—failed to confirm. This is a change in a well-established pattern of trading. A red flag started to wave. Something changed. This was a non-confirmation working yet again. This time, however, it was not the advance-decline index, but a leading group— the NASDAQ. You are not going to get a continued healthy rally unless tech stocks are fully participating. If you don’t see that happening, any rally is likely to be limited.
"Right now if someone came to me and asked what to do with money at this point, I would say keep it in money. When the market does make its bottom the odds are very high that you will have time to get in. The likelihood of a ‘V’ type bottom—moving straight up after having come straight down— is some place in my opinion between zero and none. When the market does make its bottom I believe very strongly that it’s going to take a period of time and there should be some good technical signals that will allow you to get in. I’m of the opinion that there are two or three times of the year where the backdrop of the market is strong enough where you can dive into the pool head first without checking whether there is water or not. Therefore, why do I want to invest in anything until the market starts telling me that it is making a bottom? Today, I want to keep as much cash reserves in this kind of market as possible.
"Is there a place for the long-term investor. I’d note that I am aggressive and short-term oriented. I don’t believe that any method of analysis can make a long-term projection. I’m often asked questions such as ‘Where will the market be on December 31.’ I think that’s an idiotic question. I don’t think anyone has the tools to say the market will close at 10,212.84. That’s crazy. There are two major problems with investing for the long term. When the average investor says I am in this stock for the long term what they do in effect is turn their back on the stock. What you are supposed to do with every investment you ever make is to constantly play devil’s advocate. People too often fail to recognize their errors. You buy a stock and it drops a few points. You remain confident. It drops a few more points. Your palms get sweaty. It drops a few more points. Now, you’re a long-term investor!
"If you are going to do the work and buy for the long term, at least have a plan in place to recognize when you’ve made a mistake. I feel for the guy who bought Sun Microsystems at $60 a share. I hope he was two or three months old, because he’ll have to wait for it to rise 15-fold to break even. There are certain inherent dangers in long-term investing without a plan. So please, have a plan. Don’t fall in love with stocks. They are inanimate objects. Don’t play ostrich. Remember, when you stick your head in the sand, remember what part of your anatomy is left exposed.
"My favorite joke about Wall Street is about an American who goes to New Zealand on a leisurely drive and he has to stop because there’s a huge group of sheep crossing the road. Talking to the shepherd, the American says, ‘I bet I can guess exactly how many sheep you have in your herd— and if I guess right I keep one of your sheep.’ The shepherd warns that it’s the largest herd in New Zealand. He also warns that there are many grades of sheep from the poorest possible quality to the absolute finest. The American walks around and says, ‘I’m great with numbers. You have 20,345 sheep.’ The shepherd says, that’s exactly right.’ The American then picks that sheep he wants. The shepherd then says, ‘I’ll make you another bet. I’ll guess your profession and if I’m right, I get my sheep back.’ The American agrees, knowing there were so many professions that the shepherd would never guess correctly. The shepherd says, ‘You must be a Wall Street securities analyst.’ The American was amazed and asked how he knew. The shepherd responded, ‘Because you’re so good with numbers, but still managed to pick the worst one in the herd!’"
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