Crash! Boom! Bang!
As Roxette found their way into my Spotify suggestions last week, I was reminded of lyrics that describe the recent experience of many investors: “’Cause every time I seem to fall in love … Crash! Boom! Bang!”
There have been a few really good examples of absolute carnage on both local and offshore markets in the past year or so. Still drunk on stimulus money, there were share prices that were waiting to crack. When the crack came, it was brutal.
The trigger has generally been the release of earnings or a trading update. Share prices don’t lose 30% or more without news flow to explain the drop. There are sometimes signs in the build-up to results that shouldn’t be ignored, like directors selling shares and the price running out of steam and forming an “obvious” top — and nothing is more obvious than hindsight, of course! These are ripe conditions for disappointing earnings and a capitulation in the share price.
Where does the pain end in these situations? Well, this is where technical analysis becomes really useful to figure out what the short-term moves might be. Fundamentals help greatly with the longer-term direction of a stock, but technicals are all about tactics. If you’ve ever wondered why a “crash” is 20% in some cases and 40% in others, I can almost guarantee that the answer isn’t found on page 20 of the latest integrated annual report. In most cases, the market is responding to a single number or paragraph in an earnings release. There isn’t a mob of people frantically updating their discounted cash flow models and then acting simultaneously.
Instead, the answer lies in technical support levels. This can be charted based on methods like previous troughs or moving averages. Depending on how bad the news is, the first support level may be breached, leading to a move even lower. As stop-losses are triggered or active traders jump out of the way, the market runs out of buyers until the next support line. If you have a major institution trying desperately to get out of the position, a share price can be pushed through a couple of major support lines before the dust finally settles much lower.
How quickly does this happen? Well, if earnings come out after the market has closed, then South Africans have an entire night to digest the horror story before the pain is felt in the auction the following morning. In the US, it’s possible to trade after hours, so there is some price discovery even before the next day. On rare occasions, you’ll see bad news released in the middle of a trading day, sending the market into chaos.
Rough ride
Something I’ve observed is that most of these crashes have an initial terrible day and then a second rough day as people panic for the second time. The day 2 drop can also be driven by forced selling out of leveraged positions, as those who borrowed money against the shares get obliterated. It’s rare to see a huge drop on one day and an immediate bounce the next day.
Having burnt my hands (albeit temporarily) by buying the day 1 crash in Meta last year, I decided to wait longer to buy the Transaction Capital crash. It worked out, with a 30% jump on the Friday (sadly, I couldn’t get in right at the bottom, but still a solid outcome). By the time you read this, we will all know if it was a dead cat bounce.
My biggest irritation with this situation is that I agreed with the broader market view around Transaction Capital being too expensive, but selling would’ve triggered income tax at the marginal rate (rather than capital gains tax) because I’ve held for less than three years. I was hoping that the stock would keep it together for just a short while longer so I could sell down my stake and not give a huge chunk of the benefit to the South African Revenue Service. Alas, I no longer have a gain that I can pay tax on! I have at least brought my average in-price down to R12.23, so I’m hoping to still be in the green on this one. Sadly, the highs of about R50 per share might never be seen again.
As a final word of caution, not every crash should be bought. Each case is different, something that fundamental analysis will help you figure out. Both fundamental and technical analyses are key to success in the markets.