MARKET COMMENT
The Myth of Capitulation

By James Carlisle
June 20, 2002

A bear market ends, the theory goes, when investors capitulate, holding their hands up in the air, saying something along the lines of 'it's a fair cop, guv' and offering their shares at penny prices to the sagacious, and patient, stock market bears. Not surprisingly there seems to be a lot of discussion at the moment about what would be a signal of this great capitulation. How can we tell when the time has come to pick up the pieces?

The truth is, of course, that we can't. Talk of capitulation is nonsense. If there was a way of telling when this moment would come, then the market would pre-empt it. This isn't to say, though, that capitulation talk wouldn't have an effect. It clearly should. If investors are leaving shares alone, despite thinking that they're undervalued (and that was if, remember), because they want to pick them up more cheaply later on, then the likely effect is that share prices will grind on downwards. Then, at some unpredictable point in the future, the market will recover so suddenly that those waiting for the 'right time to buy' will most likely miss the boat.

It's precisely the reverse of the sudden fall and slow recovery that many are expecting to see 'at the end of the bear market'. To my mind, that would tend to lend weight to the hypothesis. It also sounds remarkably similar to what we saw with technology shares at the height of the bubble. They ground their way relentlessly upwards, with investors saying 'of course it's overvalued but I'd be daft to sell while the price is going up'. When the tumble inevitably came, people were mostly caught on the hop.

Looking for signals that the market is about to turn is a mug's game. When the big movements come, you'll most likely miss them or, worse, be left carrying the can in the opposite direction. Far more sensible is to concentrate on diagnosing value. If you find something that you consider sufficiently undervalued, then have the confidence to buy it, whether the price has recently been going up, down or sideways. Don't wait for the market to do anything first. It won't hang around waiting for you.