Here’s the big question for investors: Is this just a correction—the usual and useful 10% or so drop that refreshes a rally for the next leg up—or something worse?
Today, pending a big rally as we head into the market close, the Standard & Poor’s 500 Index took out support at its 200-day moving average near 1100. The next stop for this market is the February 5 intraday low at 1045. That’s another 4% drop from here.
As long as the market holds that level this is just a correction. Painful. Costly. But contained and absolutely normal after a big stock market rally.
And if the S&P 500 goes below that level? Then we’re in uncharted territory. The market drop would be more than a correction, clearly. But what exactly would it be?
Could be a retracement of the normal one-third to 50% of the previous rally, the one that started on March 9, 2009 when the S&P 500 was at 677. That’s about 550 points below the market’s April 2010 top at 1209. A 50% retracement would be 1034 on the S&P. That’s not too much below the February 2010 low.
Could be something worse. The rally that began in March 2009 could turn out to be just a relief rally and the market could resume the bear trend that it abandoned, temporarily it would turn out, in March 2009. Happened during the Great Depression. Could happen again.
It’s hard for me to see that return to the bear market scenario happening, however. For stocks to resume their pre-March 2009 bear trend we’d have to see major economic setbacks in global growth. Economic growth in the United States would have to not just slow while staying positive, but the economy would have to slip back into recession. The economies of emerging countries would have to crash as well with growth in China falling to 5% and growth in countries such as Brazil and India slipping toward negative territory.
Could happen. To me it seems extremely unlikely on the fundamentals I see in the global economy. (This isn’t to say that I think we’re in a long-term secular bull market. I think the huge debt in the developed world, the need to raise interest rates and taxes, and the demographic bulge as the world ages argue that the stock markets of the developed world are in for a long-term secular bear market decline. I just don’t see a crash back to 677 in the course of a few months as part of that pattern. I think we’ll cook but we’ll cook slowly.)
It’s almost as hard for me to see any reason for stocks to stop at 1045. Almost but not quite.
I certainly don’t see any real end in sight to the budget deficits in Greece, Spain, and France and dangers they pose to the euro and to economic growth in the Euro Zone. This is going to take months to work out—if it can be worked out. (For more on why the euro crisis is so hard to fix see my post https://jubakpicks.com/2010/05/19/germany-makes-the-euro-crisis-worse/ ) I think the U.S. economic recovery is fragile—especially with slower economic growth from Europe. (See my recent post on good news that the stock market is ignoring right now https://jubakpicks.com/2010/05/19/earnings-are-solid-and-the-economys-on-track-even-if-ghe-u-s-stock-market-doesnt-care-right-now/ .) Worry about the economy slipping back into recession isn’t going away. And the central banks of the developing world will be raising interest rates for months. ( For more on when that might end, in Brazil at least, see my post https://jubakpicks.com/2010/05/20/brazils-financial-markets-already-start-to-anticipate-early-end-to-interest-rate-increases-thanks-to-euro-crisis/ ) That will certainly slow growth in those developing economies and it does raise the real possibility that some bank will overshoot and actually take a much bigger bite out of growth than intended.
So no, the worries aren’t going to vanish anytime soon.
But there’s a difference between worry and fear. Stocks can go up when investors are worried as they climb the proverbial wall of worry. Fear leads to panic selling. To dumping every stock in your portfolio in favor of safe investments such as the yen or Treasuries. Fear is what the market is struggling against—and losing to–now.
And I can see reasons that fear might be peaking.
The Senate just voted 60-40 to close debate on the financial reform bill. That legislation now goes to the floor for a vote. Why is this likely to reduce stock market fear? Because the longer the bill was open for amendments, the greater the chance that something really damaging to banks and their bottom lines would get into the final bill. (Yes, I know that Senators can still offer amendments but I think they’re less likely to make it into the bill after a successful cloture vote.) Bankers were shaking in their shoes, for example, when the Senate voted to reinstitute Glass-Steagall. That Depression-era reform prevented commercial banks from owning investment banks. Re-instituting that restriction would have forced the breakup of virtually big bank in the United States. The countries big banks can live with the current bill—or whatever emerges from the Senate-House conference, although they might not be happy about it. (Many of us, on the other hand, would be happier with some of these tougher amendments, I’d guess.)
This will start to take some of the fear out of financial stocks.
The euro actually rallied in late market action today going to $1.25306 from $1.2295. The rally was based on speculation that the European Central Bank would intervene to support the euro in the currency markets.
I think that speculation is wildly optimistic. Even if the European Central Bank does intervene its actions will be half-hearted. This bank just doesn’t like to meddle in the markets by buying euros or the debt of Euro Zone governments. This isn’t the Bank of Japan that stages currency interventions more like the Thirty Years War than the European Central Banks hit and run skirmishes.
But the rally in the euro today is still important. It reminded shorts, painfully, that betting against the euro isn’t a one-way trade. It suggested that the euro is capable of behaving like a normal currency that declines gradually while staging the occasional rally. I don’t think anyone was convinced by today’s action that the currency isn’t still headed down but the fear of a panicky plunge has dissipated just a bit.
Is any of this really good news? Not really. But what I’m interested in finding is the moment when the momentum in the bad news shifts, that moment when today’s bad news isn’t as grim and scary as yesterday’s bad news.
What you need to feed a panic is a sense that everything is getting worse at a faster and faster pace and if you don’t run for the hills immediately you’ll be road kill.
I think we’re moving toward the point where things are just bad instead of terrifying worse every moment.
How’s that for being positive?
This market correction is called for. When I posted my “20-30% of stocks (I follow) are undervalued” comment last week, I asked if anybody else performed “fair market value” calculations. I’ve scanned the comments here, and have seen no reply. However, I’ll state that when I posted this comment, my calculations showed a 12+/-7% downside for the market as a whole (if the stocks I track can be considered representative of the entire market). My calculations were in sync with Morningstar’s fair market value calculator, showing the market to be slightly overvalued last week.
http://www.morningstar.com/cover/market-fair-value.aspx
Markets tend to overshoot targets in both directions. The drop of the Euro has precipitated a need to unwind dollar carry trade investments in Europe, as well as a re-assessment of profit assumptions for US companies with heavy exposure to Europe. We could see additional selling in US stocks in the short term, but I doubt we’ll see more than 5-7% down from here, if the stocks I follow are a good indication of the S&P 500 as a whole. (Note that I haven’t actually updated my spreadsheet to reflect the drop in the Euro or any price changes in stocks since Sunday.)
I recall hearing on CNBC that S&P earnings were expected to be around $80. The S&P closed today at 1071. That would put a 13.4 multiple on earnings. That seems to be pretty rational to me, and corroborates Morningstar’s and my calculations.
So Jim – I’m always interested to hear what technical analysis says about the future possibilities. But I don’t think this market has much of a chance of hitting 677 any time soon – and maybe never again in our lifetimes. And as long as we keep investing in superb companies, we should be able to protect ourselves against the possibility that it might.
I’m glad to see that we seem to agree in our assessments. Keep up the great work, Jim! I look forward to your insight and read every column of yours.
I’m moving a good chunk out of Euro mutual funds and am about ready to start selling anything that is not a large cap dividend payer. Pretty much every major economy is a disaster and I think P/E’s are way too high relative to that fact. I’m staying below 40% on my equity exposure.
Jim
FLS has been going down fast due to their exposure to Europe. What are your thoughts?
last week i thought that Whirlpool looked good at 50bucks. i really think people should think in terms of a double dip and be out of this market. i admire jim. but i think the risk is ALL TO THE downside. and has been for a long time. the problem is not just exogonus events but that the accounting of american companies is not to be believed. many of these companies are still overvalued. banks – what happend to the toxic waste – mark to market accounting – but it is still there. There is so much debt that the dollar is doomed. And that the gov’t regardless of what they say is going to let it go weaker and weaker. I still think that cash/PHYS/CEF and more cash is the best policy. Isn’ t it logical that risk is to the downside NOT the upside and has been for a long time. I don’t think it prudent to pump stocks only cash at these levels. just my opinion.
Since no one really knows that going to happen, here is my prediction.
1. Dow drops below 200d EMA (already done)
2. Tomorrow it drops just a little more before a large rally pushing the Dow above the 200d EMA.
3. Then (after all the short sellers have covered) it will fall back below the 200d EMA for a few days before another rally attempt is made.
4. (June) This time it succeeds and breaks into the 13d EMA and trends until it clears the 100d EMA before falling back down to the 200d EMA.
5. (July) Uptrend continue but very slowly up
6. (Aug) Dow starts falling again
7. (Sept) Dow reverses only temporarily into EMA range and continues down again
8. (Oct) Dow starts dropping at a faster rate
9. (Nov) Dow continues to fall
10. (Dec) Dow reverses similar to that of March 2009 and begins the uptrend again.
May 2011 another crash happens similar to this one.
“The rally that began in March 2009 could turn out to be just a relief rally and the market could resume the bear trend that it abandoned”… Now I am terrified.
I am going watch my favored movie tonight and maybe do some research on my potential buy list.
yx…
I like your attitude!
Folks:
Do what ogowan is going to do tonight, skip watching your portfolio. Why torture yourself if you think there is nothing you can do.
Lesson from the past:
– JP Morgan said the stock market will fluctuate.
– Anyone who went through the period of Lehman collapse to March (even April) 09, should be confident that the sky is not going to fall. I think those days (the 6 months after Lehman’s fall) were much worse than now.
I hope the fear is “peaking”.
What kind of experience does Dr. Doom Ruibini have in stock investing? Zero.
Did I say before that CNBC has a show to run? Yes.
I am agree with Jim that at this moment, the US recovery (although fragile) is still on. Export to EU is only about 5% of GDP.
Ed McGon,
Glad to hear you had a good day today. I also had a good day. Did some biking, watched the local girls softball game and tonight I am gonna skip looking at my portfolio results and listen to “I ain’t gonna let it bother me tonight”, thanks for the tip!
Ed,
THe fertilizer stocks have had a large correction already, in particular a stock like AGU is almost down 30% with a nice balance sheet. How much further would it need to correct before starting to build a position?
Thanks
Ed,
I do know that RBC sold a big portion of their mortgage exposure to New Century (and by extension the U.S. taxpayer) before the crash. In the interevening years, I have read nothing on “crazy” investing in the mortgage space by any Canadian Bank. For whatever that’s worth….
T2,
Try SRS (or whatever it’s new symbol is now). Double short Comml Real Estate. Be sure to bring your stones, if you know what I mean.
Everyone else,
Good luck in the Ponzi scheme!
As I said in a recent post, it is my belief that every Country is preparing for the G8/G20 Meeting. Germany is playing tough with PIIGS, PIIGS are starting to put order in their own houses (I read that Italy will be discussing by next week 25 to 28 billion EUR austerity plan in two years). Germany is also pushing hard for European and global(?) financial and finance reforms. Same for Russia, China, etc… including naturally, last but not least, USA. There is a ranking adjustment going on between Countries. The only problem is that all this is a working progress, nothing is certain. Money, and precisely, people with lot of it, like to know the rules. Money like predictability and at the moment there isn’t, hence the turmoil. Will that end? I hope. Otherwise we will have to count all those politicians and fat cats as unemployed.
Nouriel Roubini calls for another 20% drop in stocks:
http://www.cnbc.com/id/37259541
Granted, he’s an economist. Take it for what it’s worth.
jamba,
The problem with dividend stocks in a deflationary economy is loss of principal. It doesn’t do you any good to collect dividends if your main investment is being melted away. But that is a generalization.
If you can find a good blue chip that can maintain it’s earnings AND pay a dividend, it could be a decent investment.
I wouldn’t recommend any stocks until the uncertainty factor is taken out of the markets. While Jim is right about the difference between worry and fear in markets, it doesn’t take much to go from worry TO fear.
As for your suggestion about Canadian banks, I find it intriguing, but I can’t say I know enough about Canada to recommend any. I do know their banks didn’t take the hit ours did in the real estate meltdown. But that doesn’t necessarily make them good or bad investments.
EdMcgon
Would you recommend dividend stocks if deflation is a possibility? If so would you include industrials like EMR or MMM? Or would you look at some of the Canadian banks?
Sell on rallies.. DON’T buy the dips.. Its the volume people… look at the Volume on down days!
bsdgv,
You and I don’t agree on politics, and Paul Krugman and I don’t agree on politics. However, Krugman is spot on. Deflation is a VERY real potential problem. I think we’re already seeing some signs of it (have you looked at the charts for any of the industrial metals lately?).
Just like the Leading Indicators is a joke, published GDP figure is also a joke. Employers are not employing. Consumers are not spending (http://www.consumerindexes.com/). How can we expect an upside in the economy if 60% of the economy is out of picture?
At the begining of the crisis people were asking: Can China survive without US? Well, it did. Why don’t we ask ourselves: Can the US survive without Europe and China, considering that they are both in the dumps?
> Economic growth in the United States would have to not just slow while staying positive, but the economy would have to slip back into RECESSION.
(emphasis mine)
How about deflation?
http://krugman.blogs.nytimes.com/2010/05/19/feeling-deflated/
The people who govern this country have adopted a Japanese-style economic “rescue.” Would it be too suprising to end up in Japanese-style deflation? They saved the banks instead of the banking system unlike the Swedes in 1992. There is still a large supply of houses getting even larger by new forclosures… This is not only a heavy correction. we are heading down, way down… Fasten your seat belts please.
Giggling…and I keep thinking…”Stupid is, as stupid does”, wonder why??? Think I’ll take
Ed’s advice and start singing the “don’t worry” song…
I just keep getting more liquid. I’d like to hear some short ideas.
In the immortal words of Scarlett O’Hara, “Tomorrow is another day.”
For appropriate music listening, I’d recommend Atlanta Rhythm Section’s “I’m Not Gonna Let it Bother Me Tonight”, or perhaps Bobby McFerrin’s “Don’t Worry, Be Happy”.
For your viewing pleasure, perhaps pull up a video of Gene Kelly doing “Singin’ in the Rain”.
Cheer up people. It’s only money. Yes, I had a good day today, but tomorrow I could end up giving back everything I made today. But I wouldn’t let it ruin my weekend if I did.
sans lube, unfortunately
Two big catalysts are happening today and tomorrow. Financial regulation may pass today, and the successful cloture vote got a negative reaction in the financials. Tomorro, Germany votes on their portion of the trillion $ plan.
The only thing I figured to do today was buy VXX. Who knows…
Jim,
Seems like we heard this kind of “pep talk” last summer…forget which post you made…something to the tune of “not as bad as yesterday’s awful news, but still awful”. “Fasten you seatbelt boys, it’s gonna be a bumpy ride!”
in other words bye bye money…