The Markets’ Crisis of Confidence

12/23/2008 12:00 pm EST


John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says that the Madoff scandal is just the latest in a series of blows to investor confidence in the financial markets.

The bursting of the Madoff Ponzi scheme closed the circle on hedge funds. What started as investing excesses and a consumer finance problem became a crisis of confidence amongst professionals that morphed into a general crisis of confidence and finally came back to bite the professionals once again in the form of a $50-billion hit to capital at a time when such a hit really hurt capital and confidence.

It will not be back to business as usual on the other side. Hedge funds will be smaller, more restrictively regulated. Many of the strategies that they once employed simply won't work in the newly straightened environment that they find themselves in.

Compounding the pain and further dimming the future is the refusal of many funds to return investor capital even when there is sufficient liquidity to do so, a short-sighted act which will serve to crush already diminished investor appetite for the sector.

More generally, the major factor facing the markets going forward will be investor reluctance to invest at all, which after all is the function of bear markets. In the wake of the 1962-1973 consolidation and the 1973-1974 bear market, investors simply gave up and turned their attention elsewhere. That was unfortunate, as the next years set the stage for one of the greatest bull markets ever.

We think we face the same cycle again: investor confidence has been shattered and it will take a long time to rebuild. Yet opportunities abound and the future looks bright for those who want to roll up their sleeves and get to work. Stock picking, group and sector selection, and relative strength are the things that will work best.

Meanwhile, the character of stock-market trading has improved dramatically. Whereas in October and into November the ticks would swing to huge negative values and recover to neutral only to be slammed right back into the depths, now we find ourselves in a more balanced environment, with some sense that it is again possible that ticks can again accumulate to the up side.

So, what is the fly in the ointment? The inability to put a string of several positive days together indicates to me that there is still a lot of selling to be accommodated. I suspect that this selling is money leaving the markets that won't be coming back any time soon. The real convincer would be a string of a few days in a row with good breadth and decent gains that wasn't met by a wave of selling. On the other hand, the market’s ability to deal with bad news has become quite strong.

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