Submitted by Pater Tenebrarum via Acting-Man blog [9],
Sometimes It Doesn’t Pay to Catch a Falling Knife …
We like to think that a contrarian investment approach works best in the long term. Contrarian does not necessarily mean that one simply tries to fight every trend. It is more about attempting to recognize when a trend has gone too far. In practice this is often more difficult than in theory. The theory is simple enough: buy low, sell high. However, it is nigh impossible to recognize turning points with precision. So a contrarian style often forces one to be patient, and to accept that one will frequently both buy and sell too early.
One way of dealing with this problem is to spread one’s purchases and sales out over time. We did this with Japan, to name an example. In “Reconsidering Japan [10]”, which turned out to be a well-timed post, we made the case for Japanese stocks (warning: we have our share of decidedly less well-timed posts). We didn’t know at the time that a bull market would be set into motion by what we ultimately consider a catastrophic economic policy, we only knew that the market was cheap. Our own approach was to buy in small sizes over a long time period. It took a lot of patience, as the market simply sat and sat there – the rallies never amounted to much. We felt though that the market represented a contrarian opportunity. We have occasionally mentioned similar opportunities in the past, such as e.g. Greece and even China. As we have pointed out a few times, economic fundamentals and stock market performance are often two different cups of tea. Usually we tend to be “early”, but this doesn’t matter if an idea ultimately pans out (gold investors take heart).
There is however one market that has defied contrarians to such an extent that one wonders what the hell happened. Shortly after the bail-out, when we first wrote about the enormous decline in the Cyprus General Index, we did so because at the time it represented the greatest stock market crash in history by far (see: “The Greatest Collapse in History [11]” for details). We also noted that Cyprus was in a very bad position, referring to it as “Iceland without the fish” and a “disaster zone” (which it was/is). The 98% decline in its stock market at the time might have led one to suspect that the place had been hit by an asteroid. Instead it had been hit by the EU, which turned out to be almost as bad, at least financially. We later posted a brief update on the Cypriot disaster area and noted that the market had apparently simply perished (see: “Cyprus – A Stock Market Dies [12]”).
Believe it or not, Cyprus as such still seems to be standing. Here is a recent photograph of the Limassol sea front in Southern Cyprus:
Limassol – nope, no signs of an asteroid strike or a nuclear explosion visible.
Photo credit: P. Matanski
We commented on this oddity as follows:
“The stock market of Cyprus is – so far anyway – different. We are keeping an eye on the chart of the Cyprus General index, because its decline was, as far as we are aware, the biggest decline of a stock market index in history. It fell from a high of 5,500 points to a low of just 85 points, a loss of over 98%. This means that the market lost another 85% after it had already fallen by 90% – an unprecedented massacre. It is perhaps appropriate that since then, the market seems to have almost literally expired. Its chart currently looks like the EKG of a recently deceased patient. We’re not sure what this means, except to say that contrary to past major market crashes elsewhere, this one has so far clearly not represented a buying opportunity. A very curious development indeed.”
We didn’t realize at the time that excitement would soon return to the stock market of Cyprus. It suffered yet another crash a few months later, plunging by 86% in a single day in September 2013. This is another first: a stock market that has plunged 98% from its high spends a few months drifting sideways to lower with almost no movement, and then crashes by another 86% in just one day. So the biggest market decline ever was followed by the biggest single day crash ever. In this case we can really say that “strong support at zero” is very close by now.
Revisiting the Disaster Zone (a.k.a. Iceland Without the Fish):
We don’t know for sure if the Cypriot stock market finally represents a good investment opportunity, but here is an updated chart. We were unable to find the Cyprus General Index chart (it may have been discontinued), but luckily Dow Jones has produced a total market chart for Cyprus, which serves as a suitable replacement. We are using a log chart as one would simply not see the aforementioned 86% one day crash of September 2013 on a linear chart:
[13]
A long-term log chart of the DJ Cyprus Total Market Index in euro terms (there is a dollar-denominated version available as well) – note the “crash after the crash” in 2013 – click to enlarge.
The DJ Cyprus Total Market Index is at present down 99.71% from its all time high made in 2007, so we would say it is definitely the most oversold stock market in the world in all of history. From 100 euro invested at the peak, a mere 29 cents are left.
Let us briefly ponder the mathematics of this wipe-out: when the market was down by 90%, it fell by another 50% at which point it was down 95% from the high. Thereafter, it fell by another 50%, ending down 97.5% from the high. Then it fell by another 50%, at which point it was down 98.75% from the high. Then it fell by 50% again and was down 99.375%. Surely this was bad enough? Nope…it then fell by yet another 50%, landing at 99.6875% down from its 2007 high. Unfortunately, the low was still not quite in yet at that juncture.
As noted above, the decline was punctuated by a one day crash of 86% in late 2013. What has so far been the low point was recorded in the wake of this (3.87 points, or down 99.761% from the 2007 peak). Sometimes the joys of euro area membership can indeed be dubious. Maybe this is what Mario Draghi has in mind when he lectures us on the dangers of deflation?
Amazingly, although the market bounced after its most recent crash to an interim high of about 8.5 points – up an impressive 120% from the crash low – it has since then drifted lower again for months on end, once again losing almost 50% of its value in the process. Here is a linear close-up of the action since the September 2013 crash low:
After the crash of September 2013: a 120% rally, followed by another severe bear market.
We will forward what might well turn out to be a daring theory: given that Cyprus still appears to be in one piece (in a manner of speaking, anyway), it may actually be time to throw a euro or two at its stock market. We admit that even a market trading at 4.6 points (from a former peak of 1,620) can still fall by half, and then fall by half again. And again. After all, this seems to be what this market does best. Seriously though, the above mentioned strong chart support at zero really is quite close. Worst has already come to worst, and it is increasingly hard to see what this market isn’t discounting at this point.
Almost regardless of the fundamental backdrop (which admittedly has its flaws, to put it mildly) there seems to be an interesting risk-reward proposition here. Imagine investing 100 bucks in an index basket. If the market halves again twice in succession, you will have lost 75 bucks. If an asteroid does strike after all, you will have lost 100 bucks (actually, in this case, it may take two asteroid strikes. At least one seems to be in the market already). If the market ever gets back to its former highs (this may of course never happen, but bear with us), your 100 bucks will have become about 34,500 bucks. Now that would be a return to write home about.
Conclusion:
This collapse is truly one for the history books. In many stock markets trading was suspended during war time, so theoretically there might have been even worse situations, but this is just guess work. To our knowledge nothing like this has ever happened anywhere in peace time. Assuming that Cyprus will continue to exist, it may finally be time to invest in this train wreck.
