There tends to be a lot of talk about "investor capitulation" when stocks continue to tank. But what is meant by
capitulation in Wall Street terms and what does it mean for future stock trends? This article will discuss both.
Capitulation is defined in the
American Heritage Dictionary as the following:
ca·pit·u·la·tion (n)
1. The act of surrendering or giving up. Surrender.
2. A document containing the terms of surrender.
In Wall Street the term refers to the time when investors (all of them) sell all their stocks because they want out. The sole motivation for trading is to get out of the market and seek shelter in "safe" investments such as bonds or your mattress. The selling frenzy is painful, but relatively quick. Consequently, a sign of capitulation is mass selling that occurs over a brief time span.
Historical Examples
Good historical examples are the Black Mondays of 1929 and
Oct 1987. In both cases, investors ran for the exits, producing the big market drops. In 1929, the drop was prolonged as bad economic policies aggravated the situation and created a depression that lasted until World War II. In 1987, the drop was painful, but stocks started to climb within the next few days and continued until Mar 2000.
Surprisingly, the sudden drop in the stock market in Oct 1987 was called neither a capitulation nor a crash. Other euphemisms such as "
correction" were used. While some of us realized what had occurred in real time, it took the media a long time (years) to label the event correctly.
In mid July of 2002 there was some speculation of another capitulation possibly occurring as stocks fell below their Sept 2001 lows.
The S&P 500 hit a low of 797.7 on Jul 23, 2002 (a 47.8% decline from the high set in Mar 2000). This free fall was accompanied by data that indicated that individual investors were taking money out of mutual funds and into bonds and money market funds bonds. In order to meet these withdrawals, mutual fund managers had to sell their stocks, which accelerated the drop.
A sign of capitulation? Possibly. The mass transfer of funds from stocks to safer investments and increased news stories on investors preferring their mattresses over the market replaced the go-go stories of the late 1990s, when investors poured money into dotcom stocks that had no fundamental strengths. This type of reverse is a good sign of a capitulation.
But there are two things that indicate to me that mid-July this will not be the same situation we saw in 1987. First, the very act of calling it a capitulation is a defiance of the definition. The media full of capitulation talk is a
bullish indicator. This bullish sentiment invalidates the primary criteria for a capitulation, which is the total
lack of any bullish sentiment for stocks. Second, in real-time the media is wrong in its calls on market turns. The media is a good "misleading" indicator, one that you should almost always bet against. It was late in calling the 1987 crash, the dotcom bubble, and this recession.
The media, however, is a reflection of the market's beliefs. We wanted a quick end to this two-year
bear market, just as the market wanted dotcom dreams of fast riches in late 1990. The common denominator is short time frames. Investors wanted quick riches in 2000. Today they want a sharp and quick sell-off to end the pain.
But what we face cannot be undone overnight. It took five years for the market to fund the building of overcapacity in telecom, tech, and Internet grocery stores. And it will take more than two years for the economy to absorb that capacity. It will also take a long time for investors to forget about the illusory 20% returns that the market posted in the late 1990s and get used to the idea that a good year for stocks is a return in the high single digits.
The current focus on capitulation (or a quick end to this bear market) indicates to me that the market will continue to be bearish. With economic fundamentals expected to remain weak for at least another year, stocks could trade within a range for several months. The range may be flat, or it could continue to decline if news about corporate misdeeds and terrorism persist. During this time, there could be moments of capitulation when stocks drop to the lower end of the trading range. For investor with a penchant to trade, these will be good short-term trading opportunities. For those of us who prefer to be long-term investors, it will just be frustrating.
by James Hyerczyk, (Contact Author | Biography)
James A. Hyerczyk is a registered commodity trading advisor with the National Futures Association. Hyerczyk has been actively involved in the futures markets since 1982 and has worked in various capacities within the futures industry, ranging from technical analyst to commodity trading advisor. Using Gann theory as his core methodology, Hyerczyk incorporates combinations of pattern, price and time to develop his daily, weekly and monthly analysis. Hyerczyk is a member of the Markets Technicians Association and holds a master's degree in financial markets and trading from the Illinois Institute of Technology.
