June 14th, 2010
What Ever Happened to Capitulation?
If you’ve read my research over the last few years, you’ve seen the concept of capitulation discussed a number of times. I realized recently that I failed to finish the story of capitulation as it pertains to the downturn in the residential building products industry. For those of you not familiar with this concept, capitulation is the darkest moment before the dawn, the point where a market begins to turn. In publicly traded equity markets, capitulation is sometimes deemed to happen on the type of day when a series of negative earnings announcements or news stories push the Dow down from 10,700 to 9,800. Capitulation, by definition, is swift and severe and while factors may point in advance to its occurrence, its exact timing is unknown.
However, the majority of companies serving this industry are not publicly traded, leaving us in some doubt as to when capitulation has occurred. There is no single, disastrous day that lets us wipe the sweat from our brow in the certainty that the worst is over. Instead, we look for directional signals to determine when capitulation has occurred. In other words, you know when it hasn’t happened yet because things are still getting worse. At a later point in the future, when things start to look consistently positive, you know the market has moved through a period of capitulation. The good news is that I believe this has occurred on the residential side of the market. House numbers worsened for long periods and then, later last year, they started to send mixed signals month to month. Now, with housing numbers more consistently positive, it is likely that the worst is over, capitulation has occurred and that the residential market is now gaining steam.
It would be difficult to say that capitulation has yet occurred on the commercial side. The stimulus package has helped and will continue to do so, but most commercial building products manufacturers report that they are facing continuing pressure from a soft market. The capitulative event on the commercial side may likely be the wave of commercial loan defaults predicted by most experts. Once that is over, as the worst appears to be over for the residential foreclosure crisis, the commercial market will also begin to improve. By that time, the commercial market will also benefit from the pull of a recovered residential market as well.