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Inside the Market How the search for the market bottom 10 years ago proved elusive for even the top minds of investing

My daughter was born in November, 2008, during a stock market crash. A slightly brittle, yellowing copy of The Globe and Mail from this time, which I’ve held onto as a sardonic time capsule, makes this clear.

A headline on the front page of Report on Business sounds hopeless: “Cheap stocks that nobody wants.” The S&P/TSX Composite Index tumbled 9 per cent the previous day, on Nov. 20, the second-biggest one-day loss in the index’s history, and the S&P 500 closed at 11-year lows.

Also in the day’s grim news, Teck-Cominco Ltd. (now Teck Resources Ltd.) suspended its dividend, Toronto-Dominion Bank’s chief executive discussed the bank’s surge in credit losses, JPMorgan Chase & Co. planned to lay off 10 per cent of its investment bankers and the financial aid from the International Monetary Fund and European nations to Iceland increased to more than US$10-billion.

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And in recognition that Berkshire Hathaway Inc.’s share price had fallen 50 per cent over the prior 12 months, an article deeper into the paper wondered whether the company’s CEO, Warren Buffett, had “lost his Midas touch.”

But as we mark 10 years since the S&P 500 and the TSX began to recover from their lows, it’s interesting that this bleak backdrop coincided with one of the best buying opportunities in decades.

Some observers were suggesting this. Mr. Buffett wrote an opinion piece in The New York Times, in October, 2008, when stock prices were in free fall, that now buttresses his reputation for having a golden touch.

“The financial world is a mess,” Mr. Buffett began. “In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary. So ... I’ve been buying American stocks.”

He continued: “I haven’t the faintest idea as to whether stocks will be higher or lower a month – or a year – from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.”

Similarly, Jeremy Grantham, then chairman of the Boston-based asset manager GMO, argued that stocks could easily fall further in the short term, especially if the U.S. economic recession lingered. But he saw long-term value in buying stocks at depressed lows.

“A single giant step at the low would be nice, but without holding a signed contract with the devil, several big moves would be safer. This is what we have been doing at GMO,” he said in a letter to clients in March, 2009.

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On March 9, the S&P 500 closed at 676.53, its lowest level since 1996, and many observers could see nothing but more pain ahead and adjusted their targets lower.

David Rosenberg, then the North American economist at Merrill Lynch (he is now chief economist and strategist at Gluskin Sheff + Associates in Toronto) argued that the S&P 500 would fall to 600, an estimate based on an ongoing recession that would sap profits even more.

But then, without any trigger or shift in sentiment, the index began to rise from its lows.

The news remained grim for some time after stocks began their rebound, just as Mr. Buffett said it would: The U.S. unemployment rate continued to rise, peaking at 10 per cent in October. And the U.S. Commerce Department reported in April that the U.S. economy contracted 6.1 per cent in the first quarter, later revised to a contraction of 5.5 per cent.

Within a year of its nadir, though, the S&P 500 was up 68 per cent from its lows, even as many exceptionally bright observers questioned the rally’s staying power.

Rob Arnott, chairman of Research Affiliates, a Newport Beach, Calif.-based firm that has developed quantitative investing strategies underpinning US$170-billion in assets worldwide, told The Wall Street Journal in March, 2010 – exactly one year into the rebound – that stock market bubbles tend to be followed by lengthy periods when stocks trade at deep discounts, as investors give up. The sharp rebound in the S&P 500, then, appeared flimsy to him.

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The sell-off in 2008 and early 2009, he warned, still hasn’t brought us back down to historic norms” for stock prices, Mr. Arnott warned.

Robert Shiller, the Yale University professor who wrote Irrational Exuberance, the book that challenged many of the assumptions driving technology stocks in the 1990s, also worried that stock prices had become expensive again. Mr. Shiller compares stock prices with average profits over the previous 10 years (an approach known as the CAPE, or cyclically adjusted price-to-earnings). By March, 2010, the CAPE ratio was 20, which was well above the historical average of 16.

And John Hussman, a U.S. fund manager who deftly avoided the 2000 and 2008 recessions, sat out the rebound with deep concerns about U.S. monetary policy and the health of the economy. He believed the U.S. economy was heading back into recession based on the yield curve, credit spreads, employment growth and the readings of leading indicators expressed in the Economic Cycle Research Institute’s Weekly Leading Index.

“Put bluntly, I believe that the economy is again turning lower, and that there is a reasonable likelihood that the U.S. stock market will ultimately violate its March, 2009, lows before the current adjustment cycle is complete,” Mr. Hussman wrote to clients in June, 2010.

Small investors were also skeptical. A weekly survey conducted by the American Association of Independent Investors showed that bearish sentiment hit a record high on March 5, 2009 – which, in hindsight, is exactly when investors should have been at their most bullish.

Naysayers have been steamrolled over the past decade. The S&P 500 rose to a new record high by 2013, eclipsing its previous peak in 2007. Today, the index is up 305.5 per cent from its close on March 9, 2009, or 399.7 per cent with dividends.

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Are there lessons to be learned here? Maybe, but perhaps the lessons merely reinforce our long-held strategies for investing.

For investors who embraced a buy-and-hold approach, who tuned out the noise and avoided trying to call the market bottom, the past decade has rewarded them with enormous gains.

But agile investors who can’t resist market timing will surely find vindication as well: Turning greedy when others are fearful, as Mr. Buffett likes to say, worked out rather well.

Clearly, both approaches are going to be tested if the bull market continues, or comes to a nasty end.

2008

Sept. 8: The U.S. government takes control of Fannie Mae and Freddie Mac, adding US$200-billion in Treasury support in an attempt to shore up the housing market after the two mortgage giants lost US$12-billion since the previous summer.

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Sept. 15: Lehman Brothers, the fourth-largest U.S. investment bank, files for Chapter 11 bankruptcy and collapses under the weight of its interest in U.S. subprime mortgages. Its 158-year history as a financial player ends, raising the panic level among investors. The S&P 500 falls xx per cent.

Sept. 18: The Federal Reserve, the Bank of Japan, the European Central Bank and the Bank of Canada announced co-ordinated efforts to provide liquidity to the global financial system.

Sept. 19: The U.S. Securities and Exchange Commission (SEC) temporarily prohibits short-selling in 799 financial stocks. Christopher Cox, SEC-chairman, said: “The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets.”

Oct. 3: President George W. Bush signs into law the Troubled Asset Relief Program (TARP), designed to purchase toxic assets from struggling U.S. financial institutions, backed by US$700-billion.

Oct. 16: Warren Buffett writes an opinion piece for The New York Times, entitled “Buy American. I am.” He said: "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”

Dec. 1: The National Bureau of Economic Research (NBER), a committee of leading economists, makes it official: The U.S. economy is in a recession that began in December, 2007. Now known as the Great Recession, it grinded on until June, 2009.

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Dec. 16: The Federal Reserve cuts its key interest rate to zero, from 1 per cent previously, and announced that it would buy bonds and print money to help stimulate the economy. “Overall, the outlook for economic activity has weakened further,” the Fed said in a statement.

December: U.S. unemployment rate rises to 7.3 per cent, the highest in more than 14 years. Just one year earlier, the unemployment rate was 5 per cent.

Fourth quarter: Net earnings for companies in the S&P 500 fall to 23 US cents per share, down from earnings of US$16.35 per share in the third quarter.

2009

Jan. 30: The Commerce Department reports that U.S. gross domestic product (GDP) contracted 3.8 per cent in the fourth quarter of 2008, at an annual rate, marking the sharpest slowdown in 26 years. This estimate was later revised to a contraction of 6.3 per cent.

February: The U.S. unemployment rate jumps to 8.3 per cent, and would continue to climb over the next five months until peaking at 10 per cent in October.

March 5: A weekly survey by the American Association of Individual Investors (AAII) shows that 70.3 per cent of respondents are feeling bearish about the stock market’s prospects over the next six months, the highest bearish reading since the survey was launched in 1987. The current bearish reading is 26.75 per cent.

March 9: S&P 500 closes at 676.53, down 56.8 per cent from its record high in 2007. It marks the lowest close since 1996 (though the index touched an intraday low of 666.79 on March 5).

March 15: Ben Bernanke, chairman of the U.S. Federal Reserve, uses the words “green shoots” in an interview with 60 Minutes to describe what he sees as early signs of improvement in the economy: Fed bond-buying was driving down mortgage rates, allowing homeowners to refinance, and he saw progress in business lending. “I think as those green shoots begin to appear in different markets - and as some confidence begins to come back - that will begin the positive dynamic that brings our economy back,” Mr. Bernanke said.

First quarter: Net earnings for companies in the S&P 500 rebound to US$11.78 per share.

April 11: Following a meeting with his economic team and Mr. Bernanke, President Barack Obama says: “We’re starting to see glimmers of hope across the economy.”

April 29: The Commerce Department reports that U.S. GDP contracted 6.1 per cent in the first quarter of 2009. The S&P 500 rose 2.2 per cent.

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