Segmenting Financial Markets

Lilly Rains: If I'm here to court the feminist vote, what demographic do you represent?
Frank Horrigan: Let's see...white, piano playing heterosexuals over the age of 50.
--In the Line of Fire

Marketing managers learn early about the value of segmenting their markets. Segmenting involves identifying categories of buyers so that markets can be better understood.

I've often wondered why investment managers don't make a habit of segmenting. In his letter last week, John Hussman takes a shot at it. Dr J proposes four categories of investors and their influence on supply and demand in the current market dynamic.

Fundamentally oriented long term investors are value conscious investors with time horizons of a decade or more. They prefer to buy stocks when valuations are at secular lows. At secular bear market troughs, P/Es have historically fallen to the 4-6 range and dividend yields rise to 5-6% or higher. While stock prices are off 10% from their highs, aggregate valuations are still far from the levels that suggest deep value. As such, fundamentally oriented long term investors are not likely to be a major source of buying demand at current levels since prices do not yet look intriguing to this group. If markets continue to fall, then this group is likely to scale bids as prices suggest compelling value.

Fundamentally oriented short term investors are value-conscious, but in what Hussman calls in an 'erroneous and myopic' way. This group often takes cues from forward P/E multiples which often provide deceptive signals of value. Forward multiples tend to be overly optimistic and cause this group to buy much higher than the long term group discussed above. They are likely to see recent price declines from last month's highs as a buying opportunity. Thus, this group surely constitutes one source of demand currently.

Technically oriented long term investors look at long term chart patterns and other technical indicators to assess secular bullish and bearish trends. Currently, this group is undoubtedly quite concerned over multi-year breakdowns in index and individual stock uptrends. In fact, as prices broke through major support levels, this group was more likely to be a source of supply as sell stops were elected below these support levels. Currently this group is trying to assess direction of the next multi-year trend. After the major damage that has occured in many technical indicators, technically oriented long term investors may be prone to see the next multi-year trend as being lower. Thus, this group may be a persistent source of supply from these levels.

Technically oriented short term investors are also chart watchers, but their time horizon is measured in hours, days, or weeks rather than in years. After the meltdown in prices over the past week or so, many in this group saw markets as oversold in the near term and due for a bounce. This group has likely been a major source of demand over the past few sessions.

I find this a useful framework for determining who may be on either side of the trade currently.

Which of the four 'buckets' do I fall into? Well, under this scheme I participate in multiple categories. While I my strength and interest is primarily as a fundamentally oriented long term investor, there has been little for there to do from the long side. As such, I have been attracted to shorter term fundamental and technical opportunities. For example, I was buying them in the hole a week ago into what appeared to be an oversold market in the near term (technically oriented short term investor category).

Of course, that source of demand has already become a source of supply as I have been piecing out inventory as prices have moved higher...

Personally, I'm trying to once again elongate my horizon as the short term space seems pretty crowded.

position in SPX