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It Pays to Buy Panic - The Schannep Capitulation Indicator.

S&P 500 Index - Returns Following Capitulation - Aug 2012

Subscribers may recall that from late July to mid-August last year (2011) markets went into a tailspin. Many called it the start of a new bear market. This website, using a capitulation market timing indicator, suggested that we were near the end of a (mini) bear market and not at the start of a new bear market at that time. Our call now looks to have been the sounder one.

As a reminder for both long-standing subscribers as well as newer subscribers, capitulation is that event in markets where investors collectively throw in the towel. As all investors are selling together, the markets cascade downwards in a frenzy of selling. It is nerve-wracking at these times but history tells us that such occasions are more likely to mark the end of a bear market, and not the start of a new one.

On 8th August 2011, the Schannep Capitulation Indicator, developed by Jack Schannep in the 1960s (of the book Dow Theory for the 21st Century), signaled that the US market had capitulated and that it was not the time to sell but to buy. As I subscribe to Jack Schannep's website myself, I can keep an eye on this and other market timing indicators that he has developed and follows. Indeed, I converse regularly with Jack Schannep and he has been of immense assistance in one of the chapters in my upcoming book, for which I am deeply grateful. His capitulation indicator is tricky to explain, but I'll have a full explanation of it in the upcoming book. On the evening of the 8th August, I sent an email alert to subscribers suggesting that you should hold tight or even add to your positions if you could do so. That has proven to be the correct call.

Schannep's Capitulation Indicator has given only 14 such 'Buy' signals since 1970, and the table above highlights the subsequent one-year returns following each of those 'Buy' signals. The results are stunning, in my view. The evidence from history strongly suggests that when everyone panics and sells together, it is time to buy. The average one-year return following a 'Buy' signal from Schannep's Capitulation Indicator on the US S&P 500 Index since 1970 has been 24.5%. Had you bought an S&P 500 ETF on the 8th August 2011, after this website sent out an alert, the return over the past year has been 25%, in line with the long-term average.

Equally impressive is the fact that positive one-year returns followed the Schannep Capitulation Indicator 'Buy' signal on 13 of those 14 occasions. In other words, only once did the indicator fail to result in positive returns one year later. That one time was following the 'Buy' signal given on 20th September 2001, when markets capitulated following the terrorist attacks on the World Trade Centre in New York. The subsequent one-year returns were negative. But the US stock markets were still grossly overvalued in September 2001 suggesting that the capitulation indicator is less likely to deliver positive returns when a market is overvalued.

On 19th August 2011, using my own 30-week moving average capitulation indicator, the Eurozone equity markets signaled a capitulation event and thus registered a 'Buy' signal. Next week, I will look at the subsequent one-year returns from 19th Aug 2011 to 17th August 2012 on the Eurozone equity markets. Last year, when many commentators argued that the Eurozone equity markets were likely to decline further, gillenmarkets's simple in-house capitulation indicator suggested otherwise. In order to not let volatility unnerve you, it is vital to understand what is priced into markets already. If everyone is selling together, history tells us that the bad news is being rapidly discounted.

Rory Gillen
11th August 2012