Capitulation: Are we there yet?

10th October 2011

By definition, it is also the bottom of the market because everyone who was going to sell has sold. As such, it represents the perfect buying opportunity and a lot of time and effort is put into identifying capitulation point in the market.

This is easy to do with hindsight. Articles such as this one from Samuel Brittan in January 2005 were common at the time. This was just a few months before the FTSE 100 took off on a dizzying two year bull run.

Importantly, capitulation is not just panic, though panic can be a symptom. CNBC tackled the issue recently and suggested capitulation will usually see a sell-off of more than 10% in a day, high volume and panic selling. This article by Mark Hulbert, highlights some key psychological characteristics of capitulation. He says: "Capitulation has a number of distinguishing psychological characteristics, such as investor disgust and exhaustion. Having been burned by the market for so long, investors capitulate by resolving never, ever, to trust the market again."

The blogosphere is devoting some time to trying to identify whether it is happening at the moment. A few believe that the FTSE 100's dip below 5,000 and the weakness of the Dow and S&P this week marked a capitulation point.

However, Keith Springer argues on Seeking Alpha that we are some way from capitulation in the current market: "Of course at some point, we get to a climatic action, a capitulation that tends to occur near market bottoms. To explain this I need to get a little technical here. Climactic price action tends to occur on Volume that is much heavier than normal…Yesterday's Volume, at 5.8 billion shares, was 1.2 billion shares above the current 30-DMA. Therefore it's probably not the capitulation that tends to occur near important market bottoms."

Most of the posters on Seeing Alpha agree, though a couple suggest he is being too pessimistic. Untrusting investor says: "Agree that capitulation has not happened yet, but will happen at much lower lows."

This view had some support in a recent Lex column – which suggested that institutional investors were holding firm and therefore a true clear out of markets, one that would signal the bottom, was some way off. Certainly on the traditional definitions – 10% sell-off, high volume and panic selling – the recent market weakness could not be defined as capitulation.

So what could create it, given that all the bad news we have had in markets does not appear to have done so? Clearly a Eurozone default, a break-up of the Euro or instability in the US would be critical factors. That said, it is unlikely to be a significant leap. This article shows how unpopular equities have become, both as a structure for companies to raise money and as asset class in which to invest. It states: "JPMorgan calculates that over the past month, the 250 biggest US stocks have moved more in lockstep than at any time since the crash of 1987. And with the overall market swinging daily by several percentage points, that makes rational stock-based investment impossible."

The final thing to remember is that not all markets may capitulate at the same time. This piece on zerohedge on the possible capitulation in credit markets created some interest online. Investors waiting for one big universal sell-off may miss the sell-offs going on more quietly elsewhere.

Identifying capitulation is important because it can be an extremely attractive buying opportunity, but if spotting it were easy there would be a lot more stock market millionaires around. 

More from Mindful Money:

Market crash: The illusion of knowledge

The politicisation of markets: Do you need to factor political-risk into investment decisions?

Market crash: The secret to investment timing

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