S&P 500 Near Overbought Levels

At its peak yesterday, the S&P 500 briefly traded more than one standard deviation above its 50-day moving average before closing slightly below this overbought threshold.  Since the S&P 500 peaked in October 2007, prior occurrences where the index has closed at overbought levels have been relatively rare and brief.  Following prior instances, the S&P 500 has quickly reversed and headed lower.  Overbought levels can be worked off either with sideways trading over time or by falling prices.  Therefore, how the market reacts if we hit overbought levels in this rally will help to determine whether or not this is just another bear market rally (lower prices) or something more sustainable (sideways trading).

Source: Bespoken

100 Days from Major Troughs

Credit Suisse Fixed Income Group noted the diversity of performance around the first 100 days of major
market lows in US equities.

The first of these shows the past episodes that might turn out to be the most relevant. Note that one of these is the post 1929 crash bear market rally – it just happened to be 46% or so over five months. Which is actually typical of the first year of major bull markets.

The second shows some less exciting episodes that were nonetheless significant market
bottoms rather than mere staging posts towards significant new lows.

Source:
The First 100 Days
Jonathan Wilmot, James Sweeney, Matthias Klein
Credit Suisse, Fixed Income Research, 26 March 2009

http://www.credit-suisse.com/researchandanalytics

Get used to bear market rallies -Richard Russell

“Moving on to the stock market, subscribers will have to get used to bear market action. In bear markets, counter-intuitively much of the time is spent with stocks rising, due to the frequent upward correction. For instance, during the horrendous 1929-32 bear markets there were no less than nine 15% rallies, the average lasting 15 days.

“During the 1937 to 1942 bear market, there were nine rallies of 15% or more with the average correction lasting 82 days

“During the 1946 to 1949 bear market there were two 15 % or more rallies averaging 57 days each.

“During the recent 2000 to 2002 bear market there were three 15% or more rallies averaging 5 days each.

“From November 2009 to January 2009 there were two rallies, one short and one longer one that stopped just short of 15%.

“So we have to get used to rallies in the bear market. One difficulty in dealing with bear rallies is that they can end as suddenly as they started. This is because bear market rallies don’t end with a period of distribution. The buying just stops, and down they go. This is opposite to bull market advances that usually terminate after a period of deliberate distribution.”

Source: Richard Russell

Is this Stock Market Rally Real ?

Is this stock market rally for real, or is it just an upward correction in a bigger bear market?

The worrying aspect is the rapidity with which the price increases have occurred. To gauge just how “violent” it has been, Mark Hulbert of  MarketWatch, compared the rally since the March 9 lows to a composite of the stock market’s behavior over the first two weeks of all bull markets since 1900. The graph below indicates that the market is perhaps in need of catching its breath.

Percentage of US Stocks Above 50-Day Moving Averages

Below we highlight the percentage of stocks trading above their 50-day moving averages for the S&P 500 and its ten sectors.  This is a good breadth indicator to measure the underlying strength or weakness of rallies or declines.  As shown, 62% of the stocks in the S&P 500 are currently trading above their 50-days, which is getting close to the 75%-80% level that we’ve seen at prior market peaks during this bear market.

In the Financial sector, 69% are trading above their 50-day moving averages, which is the highest level in about a year.  This speaks to the strength of Financials during this rally.  On the other hand, Industrials, Health Care, and Utilities all have less than 50% of stocks trading above their 50-days, which means breadth has lagged during the rally for these sectors.  Breadth has been strongest for Technology, Materials, Energy and Telecom.  More than 70% of stocks in each of these sectors are currently trading above their 50-days.

Source: Bespoke Research

Biggest Dow Point Gains and Percent Gains

Today’s 497.48 point move (6.84%) for the Dow was the 5th biggest one-day point gain and 23rd biggest one-day percentage gain.  Below we highlight a list of the biggest point and percentage gains for the Dow since 1900.  We’ve now had 11 400-point up days during the current bear market, so as happy as they make investors feel, they haven’t been out of the ordinary.

Source: Bespoke Research

What MUST Happen Before a New Bull Market Starts?

by Marty Chenard

It has probably been a few months since we last shared our Institutional Index chart with you.

Many of you know that following what Institutional Investors are doing is critically important for investors. With over 50% of all the daily volume coming from Institutional Investors each day, it makes them the “big guns” in the stock market. Going against them is always a bad idea … if they are selling and you are buying, you will lose the game. (The Institutional Index is a compilation of the action of the “core holdings” owned by Institutional Investors and is posted daily on our paid subscriber site.)

Many investors are thinking that the market is done moving down and on the way up. Is “on the way up” supposed to mean that we are now starting a new Bull Market?

One thing for sure … if the Institutional Index is not “on the way up”, then the rest of the market is NOT going to be “on the way up” without them.

One thing I like about the Institutional core holdings index, is that it can’t get manipulated. And because of that, technical analysis levels are usually “right on” … just like in the old days.

For instance, take the peak of the last Bull Market shown on the chart below. The day the Bull Market ended was an EXACT 61.8% Fibonacci retracement.

So, what is the Institutional Index showing us now?

It shows that very severe damage has been done to the stock market. Its recent low is the worse in a decade and its recent Bull Market high was only a 61.8% retracement of the dot-com bull market high.

More importantly, the Institutional Index shows no sign or confirmation of a new Bull Market rally starting. If fact, the index has not even reached its Bear Market resistance line shown in green.

Before a new Bull Market happens, the index will need to challenge the resistance line, break through it, survive a retest of the lows of at least the 2002 lows, and start to making higher/highs and higher/lows. This is all part of a healthy bottoming process, and we are NOT going to skip all those steps.

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Why I am bullish on gold – Richard Russell (Dow Theory Letters)

“I started building my gold position in 1999. At the time gold was flat on its fanny well below 300 – what few gold mining shares were still alive were selling under $5. I wrote at the time that many gold shares were so cheap that you could buy them as if they were perpetual warrants. My gold position now is comparable to my market position back in 1958. My gold position represents maybe 30% of my total worth. Why have I done this again?

“For the following reasons:

(1) I believe gold is in a major or primary bull market. I believe the gold bull market is currently in its second phase. This is the phase where sophisticated and seasoned investors and the funds enter the market. I don’t believe the public is in the gold market to any extent. They are interested and watching the action, but they do not have the nerve to buy gold. In fact, the public doesn’t know how to buy gold, although ads are now appearing telling them of the ‘wonders’ of gold and how they can buy the coins (at huge premiums over spot gold).

(2) If there is only one bull market in progress, it will attract broad new coverage and attention – just as Thursday’s $70 rise in gold did.

(3) I believe the bear market in stocks will continue erratically and the deflationary trends will persist. This will drive Fed Chairman Bernanke up the wall, and I think he will stop at nothing (including massive printing of dollars) in his effort to halt deflation.”

Source: Richard Russell, Dow Theory Letters, March 20, 2009.

What are the signs of a final bottom? – Richard Russell

“Will the evidence come from the D-J Averages? I think it might. At the final bear market bottom, we should see:

(1) a dramatic non-confirmation by either the Industrials or the Transports (this is what occurred in 1974).

(2) or we might see an extended ‘line’ in the Averages, in which the Averages fluctuate within a 5% zone for many weeks on low volume. At some point both averages will surge higher on increasing volume.

(3) Values – We will see blue chip stocks selling ‘below known values’ with P/E ratios at single digits and the yield on the Dow near 6%.

“In the area of the final bear market lows, public attitude towards stocks and the stock market will be black-pessimistic and even angry. Wall Street will be despised and denounced as a scam. Actually, we are beginning to see just a bit of that via the highly-publicized debate between Jim Cramer and John Stewart, in which Stewart literally calls both Cramer and Wall Street a fraud.

“Already the public is turning against Wall Street, and, of course, the Bernie Madoff scheme only adds to the public anger against the ‘crooks of Wall Street’. Already, the ‘buy and hold’ creed (religion?) is being denounced along with the image of stocks as wealth-building vehicles. Warren Buffett is being tarred and feathered – Berkshire Hathaway lost billions of dollars over the last year, despite Buffett’s cheer-leading role a few months ago when he announced that he was buying stocks.

“Taking it to the present, the big question is whether we have already seen the bottom of the bear market and whether the recent strength in the market is the beginning of a new bull market. My opinion is that the latest rally is part of a bear market correction – not the beginning of a new bull market. The primary trend was recently re-confirmed as bearish when both the Industrials and the Transports broke to simultaneous new lows.

“One hint as to where we are is that prior to a major low, Lowry’s Selling Pressure Index (supply) turns down while their Buying Power Index (demand) leads on the upside. This did not occur at or near the recent lows.”

Source: Richard Russell, Dow Theory Letters, March 16, 2009.

Gold and Gold Stocks During Periods of Deflation and Inflation

I’ve heard more than a few pundits question an investment in gold or gold stocks in the current environment. They point to deflation and the lack of inflation in the foreseeable future as reasons why precious metals should be avoided. Sounds intelligent on the surface but it reveals to this analyst, a lack of any thought and analysis.

We must remember that success in trading and investing often requires a counterintuitive approach. The markets often go the opposite way they should. Here are a few examples. Gold was in a bear market for 20 years despite what can be called a credit hyperinflation in the United States. Gold has performed spectacularly this decade in the absence of the kind of price inflation we saw in the 1970s. Treasuries have risen this decade along with Gold, Oil and Commodities. When has that happened in history?

Now back to precious metals. The main idea for investing in this sector is to protect your purchasing power or protect against inflation. So it makes sense to buy the sector during an inflationary period. Right? A look at history combined with some common sense analysis reveals that precious metals and the producing companies outperform during deflationary periods and in advance of an inflation cycle.

Let’s look at the 1930s and 1940s. The Great Depression initially was a deflationary event but it concluded in inflation. Using the calculator from inflationdata.com, I calculated the change in prices in the 1930s and 1940s. In the 1930s, prices fell 18%, while they rose 70% in the 1940s. But what happened in the markets?

Which gold bug hasn’t seen this chart of Homestake Mining, from http://www.gold-eagle.com. If I remember correctly, its bull market lasted from 1921 to 1937. The stock made a lower low in the early 1940s and wouldn’t surpass its Great Depression peak until the 1960s. The stock performed especially well from 1931 to 1934, during the later stages of deflation and initial stages of inflation.

This is a chart of the Barrons Gold Mining Index, dating back to 1939. Thanks to http://www.bgmi.us. The rectangle shows 1940 to 1950. There was deflation in the 1930s and huge inflation in the 1940s. Yet the gold stocks performed far worse in the 1940s.

It was the commodity sector that prospered most during the inflation of the 1940s. The rectangle shows 1933 to 1951. Chart from TopLine Investment Graphics: http://www.topline-charts.com/.

The reality is that the precious metals complex outperforms AHEAD of reinflation, while the rest of the commodity sector outperforms DURING the ensuing inflation. Gold stocks perform best when their margins are expanding. That can happen when the price of Gold stays flat and cost inputs (oil, steel, labor) fall. It can happen when gold rises and rises faster than cost inputs. When inflation begins to take hold, the precious metals complex has already anticipated it. Inflation raises the cost of everything. As the cost of steel, oil and labor rise, it hurts the profit margins of gold producers. Hence, gold companies outperformed during the deflation and early reinflation of the 1930s, but underperformed during the inflation of the 1940s.

How did the gold stocks do in the 1970s? The aforementioned BGMI index, rose from a bottom of less than 100 to a peak of about 1300. Let’s call it a 14-bagger. Outstanding right? Well, consider that the price of Gold rose from $35/oz to as high as $888/oz. That is a 25-bagger! Gold stocks unperformed Gold despite a rising gold price. Why? Because of rising commodity prices and rising inflation, gold companies didn’t benefit as much as you’d expect. In relative terms, gold stocks were better performers in the 1960s. The BGMI rose very nicely, while the price of gold remained fixed.

In the early 2000s, there was a fear of deflation. As you can see from the chart below, from 2001-2003 gold stocks strongly outperformed gold as well as commodity stocks. Gold bottomed before the rest of the commodity sector and advanced before inflation began to take hold. As inflation began to take hold, the gold stocks underperformed both gold and commodity stocks and even while the price of gold rose from $600 to over $1,000.

Conclusion

It appears the consensus is wrong on both counts. One side says there is no inflation on the horizon, so the precious metals sector isn’t an appropriate investment. The other side says that there will be hyperinflation, so buy gold. Hyperinflation may be good for physical gold but it is deleterious to everything else including society and the political structure. The reality is that the current macroeconomic environment is most advantageous for gold stocks and then gold. However, if and when inflation begins to take root the precious metals complex will underperform and your funds will best be utilized elsewhere. For more on this analysis, visit our website and consider joining our newsletter. Good Luck!

S&P 500 +3% Days During The Bear

Yesterday was the 26th day that the S&P 500 has gained more than 3% during the current bear market (started 10/9/07).  For those interested, below we provide the change on the day following these 3%+ days.  Of the 25 prior 3% days, the S&P has gone up the next day just 32% of the time with an average change of -0.51%.  However, the last two 3% moves (both during the current rally) have seen positive returns the next day.

Technical Talk: S&P 500 up against resistance levels

Back to where we started … As seen in the graph below the S&P 500′s multi-day rally back from the dead has brought the index smack dab backup towards its recently broken support zone near 780 to 740. This zone of resistance is likely to stall this rally short-term given the fact so much trading activity occurred around this level before it finally gave way. However we are never one to argue with the tape and certainly the advance/decline stats as well as the up to down volume readings the last two days suggest this market may be able to overcome this resistance easier than we would have previously imagined.

Click on the graph for a larger image

Additionally with AAII Bullish Sentiment as low as 18.92 last week there is certainly enough bearish sentiment out there to suggest investors are under-invested and sideline cash is quite ample to support a continued bear market bounce. With the quarter ending in just a few weeks we would also imagine that institutional (long only) managers will add liquidity here as to not fall too far behind the market relative return numbers.

If this resistance zone is taking out over the next few days week then the next resistance zone for the S&P 500 would be at 950.

FX, Bond Yields and Oil Prices

Oil gains 40% from its February lows, trading at $47.47, and $1.00 below its 100-day moving average, a trend that hasn’t been broken since August 2008. The simultaneous advance in US bond yields along with oil prices may appear unusual given the erosion in global economic growth. But it is all about supply as increasing supply of US borrowing (another weekly batch of +$60 billion in US Treasury auctions) and mobilized stocks of US crude oil constitute the main forces behind the ensuing price dynamics in Treasuries and WTI. WTI eyes $51.00 as the next key target, while 10-year yields have yet to breach the 3.05% level.

While the notion of rising US bond yields and a falling dollar may sound counter intuitive to those who firmly believe in the direct yield-FX relation, such is not the case when bond yields are driven up by increased borrowing rather than increased growth/inflation expectations. In the case of crude oil, the WTI benchmark has now resumed its more normal pricing of reclaiming its premium above London Brent, after being priced at a discount since November. Sundays upcoming OPEC meeting may be a decent excuse for rising oil prices, but the escalating supply builds at the Cushing hub have finally triggered orders from refineries at prices not seen since 2003.

The implications of rising oil prices and US bond yields are USD-negative, especially if the ensuing bear market bounce in global equities extends ahead. As this takes place, markets start using the growth argument to rationalize the rise in oil prices and bond yields, which would only accelerate USDs sell-off against non-JPY currencies. A temporary return to risk appetite defined as no more than 25% rally in equities (see charts below) could subject the USD to particularly hefty losses against AUD (0.68), EUR (1.31) and NOK (6.60).

Finally, jump in risk appetite comes as no surprise to a market standing at 16-17 yr lows in the major US indices, lacking major US economic data and providing bottom pickers to mount what may be the first real signs of a bear-market raly since January. While pundits are discussing the importance of closing above 700 in the S&P, the next major resistance stands at 775, followed by 805 until we’re likely to see renewed downside. As signalled in today’s morning IMT, Aussie and Nokkie respond best to today’s rally (see AUDCHF in today’s HotChart), while GBPUSD sends a negative signal by failing to close above $1.3850 in London trade. Such a failure in NY close would cast prolonged negative dynamics on GBP.

While last week’s feature article highlighted the deteriorating fundamentals in the Canadian dollar, todays piece reiterates the case for the Australian dollar, which appears set to exploit any advances in risk appetite as the currency is characterised with superior structural foundation (lowest external deficit in 7 years, lowest budget deficit in G10. Readers of my HotChart section have seen an array of calls favouring AUDCHF, AUDJPY and AUDCAD. The Aussies strength was also manifested in the currencys out-performance of the CAD, NZD and GBP during bouts of risk aversion (falling stocks).

Short-Covering Driving Today’s Gains

One of the best ways to determine how much short-covering is behind bear market rallies is to create a portfolio consisting of stocks and ETFs for which there is a large outstanding short interest.

With an eye toward sorting out short-covering activity in a future rally, I put together one such portfolio yesterday, using the Finviz.com screener to identify high volume securities where short positions are a large percentage of the float.

The results are below and show that the ten stocks in this portfolio are up an average of 11.8% halfway through today’s session, suggesting that short-covering is fueling a large portion of today’s rally. Note that 7 of the 10 holdings are up more than 11% today, led by Deutsche Bank (DB) and MGM Mirage (MGM).

Dispelling Myths About Stocks in the 1930s

By MARK HULBERTThe Depression wasn’t as bad for stocks as many think. That could bode well for the future.

MUST WE LOOK BACK TO THE Great Depression to really understand the current stock market?

A year or so ago, when a select few investment newsletter editors began arguing that we need to do so, the overwhelming majority of advisers believed that drawing such an analogy served little purpose other than fear mongering.

It is testament to the severity of this bear market that the consensus opinion has shifted so much that it is now respectable to look to the 1930s for guidance about what is in store for equities.

I’m skeptical, however. That’s not because I don’t think that decade has much to teach us.

My skepticism instead traces to the small number of analysts and commentators who have really analyzed what an analogy to the 1930s truly entails. And if we are to genuinely learn the lessons of history, we have no choice but to start with an accurate assessment of what actually happened.

After examining several aspects of the stock market’s behavior during the 1930s, it would appear as though a replay of that decade might very well be less scary than assumed by many of those who superficially draw the analogy.

Here are some myths about the Depression that should be dispelled.

MYTH 1: It took 25 years for the stock market to recover its losses from the high reached just before the stock market crashed in October 1929.

It’s easy to see why investors believe this myth to be true: It wasn’t until Nov. 23, 1954, that the Dow Jones Industrial Average closed above the level at which it closed on Sept. 3, 1929, the date of its closing high before that year’s crash. That’s a recovery period of more than 25 years.

If the recovery from the bear market over the last year and a half were to take the same length of time, the Dow wouldn’t again close above its all-time high from Oct. 9, 2007, of 14,164.53 until — you’d better sit down — Dec. 28, 2032.

The truth, however, is that it took stocks far less than 25 years to recover. According to Wharton finance professor Jeremy Siegel, the inflation-adjusted total return index of the U.S. stock market was just as high in late 1936 and early 1937 as it was at its precrash peak in 1929. That was less than eight years later.

That may not be great news to investors who are hoping to recover their bear market losses in just one or two years. But it’s a whole lot better than taking 25 years to recover those losses.

WHY THE BIG DIFFERENCE?

One factor is dividends, which were substantial during the 1930s. At the depths of the Great Depression, in fact, the Dow’s dividend yield was in the double digits. Ignoring dividends, which is what investors do when focusing on price alone, therefore, introduces a significant pessimistic bias into any historical analysis.

ANOTHER FACTOR IS DEFLATION: The consumer price index actually dropped by 27% between its 1929 peak and its low in 1933. A stock that dropped by less than this amount in nominal terms over this four-year period, therefore, actually turned a profit in inflation-adjusted terms.

Yet another reason why it took the Dow so long to surmount its 1929 peak: The decision in 1939 to delete International Business Machines from the average. It wasn’t added back until years later. According to Norman Fosback, editor of Fosback’s Fund Forecaster, the Dow would today be more than twice its quoted level had IBM not been removed from the average in 1939.

MYTH 2: If we’re playing out a 1930s script, now would be a bad time for long-term investors to get into the stock market.

Actually, if the stock market were to exactly adhere to a 1930s-like script, equities would provide a handsome return over the next five years.

Once again, this insight relies on data from Professor Siegel. To locate the date during the 1930s that is most analogous to today, he looked for the point at which the stock market after 1929 had — as is the case today — declined by around half on a dividend-adjusted and an inflation-adjusted basis. That point came at the end of 1930, just 16 months after the August 1929 stock-market top. (Ironically, of course, the current bear market is just 16 months old too.)

According to Siegel, over the five-year period beginning in January 1931, the stock market produced an inflation-adjusted total return of 7%. That’s right in line with stocks’ long-term average performance, in fact.

To be sure, this myth does have a big grain of truth to it. Over the first five months of 1931 — the first five months of this five-year period — the stock market fell 60%. You read that right: That’s a 60% drop on top of a 50% drop over the previous 16 months.

If the stock market today were to suffer a further decline of similar magnitude, the Dow Jones Industrial Average would be trading below the 3,000 level by the end of July.

So, to that extent, it is true to say that, on the assumption we’re playing out a 1930s-like script, now would not be a good time to enter the stock market. But this truth pertains more to shorter-term investors than to longer-term investors. According to Siegel, in fact, an investor who entered into the stock market in early 1931 was made whole again by June 1933, despite digging a 60% whole in the first five months.

MYTH 3: The stock market’s recent extraordinary volatility provides a clue to the wild ride that lies ahead if we’re playing out a 1930s-like script.

Actually, undeniably large as it has been, recent volatility doesn’t even begin to compare to what it was like during the 1930s.

In fact, there were eight calendar months during the decade of the 1930s in which the Dow rose or fell by more than 20%. The month with the biggest Dow move was April 1933, when the Dow rose by 40.2%. In August 1932, furthermore, the Dow rose by 34.8%.

The biggest monthly losses during that decade were almost as big. The largest came in September 1931, when the Dow lost 30.7%.

These monthly changes dwarf what has been seen in the current bear market. The biggest calendar month loss so far came last October, when the Dow fell by 14.1%. The second biggest came in February, when the Dow fell 11.7%.

To measure the magnitude of the stock market’s volatility during the 1930s, I calculated the standard deviation of the Dow’s monthly returns on a trailing 36-month (or three-year) basis. In mid-1933, this statistic rose to 15.4%, an extremely high number. During the current bear market, in contrast, this comparable statistic has never risen above 4.1%.

The bottom line? If we are indeed playing out a 1930s-like script, we have an incredibly wild ride ahead of us. But for those who have the intestinal fortitude to hang on, such a story would have a surprisingly happy ending.

Commodities Showing Relative Strength

While stocks have made new lows commodities have held up well and especially in the past few months. Compared to stocks, commodities have actually hit a new bull market high (relative terms).

Take a look at a long-term chart of the CCI/SPX ratio. (I prefer to use the CCI, as the CRB is too heavily weighted in Oil). The ratio peaked in July 2008 at 0.49 and bottomed in December 2008 at 0.35. It has rallied all the way to a new high at 0.51. The ratio remains well below its peak in 1980 and from an Elliot Wave standpoint, appears to be early in Wave III. Look for commodities to continue to outperform stocks in the coming months and years.

What about commodities in nominal terms? Below is a monthly chart of the aforementioned CCI. During the past five months the market has tried to find a bottom while spending most of its time from 341 to 375. On the chart we highlight two very important support points at 337 and 348. The first (337) marks the high of the previous bull market (in 1980), while the second (348), marks the 62% retracement point of the 2001 to 2008 move. While the market has struggled to find a bottom, it has remained above both levels on a monthly closing basis.

Longs should look for a weekly close above 375 to signal at least a medium term bottom. We expect commodities to recover nicely over the next several months, but it is unlikely that this is the final bottom in terms of time.

One market to keep an eye on with respect to commodities is the US Dollar. There have been so many calls for a top in the dollar that I’ve lost track. One thing is certain. Tops usually take longer to form than bottoms. The dollar isn’t just going to start falling precipitously. First it has to break its uptrend and then it has to confirm a breakdown through 80 on the dollar index. Keep in mind that a renewed bear market in the dollar necessitates a renewed bull market in the Euro and foreign currencies.

Speaking of the dollar index, we see the potential development of a head and shoulders pattern. The current rally looks to be forming the head of the pattern. In any event we don’t see the dollar breaking down until near the end of the year at the earliest. We note the possibility for marginal gains in the very short term, but the medium term uptrend is exhausting itself and this will help fuel a recovery in commodities and commodity shares.

US Bear Market Losses: $11 Trillion Dollars

By Barry Ritholtz

Here is a mind blowing stat:  Stocks have lost $11 trillion in market value since the October 2007 peak, according to Marketwatch.

This is based on the Dow Jones Wilshire 5000 index, which includes nearly every U.S.-listed stock. Losses since the start of 2009 are $2.6 trillion. Nearly half of all stocks in the index are now trading at less than $5, and 37% are under $3.

Nearly 50% of all stocks in the Wilshire 5000, the broadest index of U.S. equities, are trading for less than $5 per share, and 37% are under $3.

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Wilshire 5000 October 2007 to March 2009

Major US Market Index Movements

As shown in the table below, the major US indices suffered another miserable week, recording eight losing weeks out of nine in 2009 and falling to 12-year lows. The Dow Jones Industrial Index’s 2009 year-to-date decline of 24.5% is by far the worst start to a year after 44 trading days since 1900. According to Bespoke, there have been 19 previous years where the Dow was down 5% or more at this point, and only four of those years ultimately finished in positive territory.

The Dow is currently down by 53.2% since its peak of October 2007. Chart of the Day points out that since 1896 only the bear market that started in 1929 has produced a larger slump.

S&P 500 Price Earnings Ratio (Long Term Chart)

President Obama said:What you’re now seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal, if you’ve got a long-term perspective on it

While cheerleading the US economy and stock market is part and parcel of being the president, that his is a fairly accurate description:

And while some are pointing out a dichotomy between Obama’s pronouncement and his advisor Buffett’s description of the US economy as being in “shambles”, there really isn’t a conflict with the two views as long as you realize that the economy and the US market are two different things.

In any case, the data for February and March 2009 are an estimate only and take us down to 12 – which is without an argument a very low P/E Ratio. But not as low as we’ve seen the price earnings ratio go.

In August 1982, the PE Ratio dropped below 7. And in both July 1932 and July 1921 it went below 6. To see that scenario again, the S&P 500 would have to drop another 40-50% to the 430-360 level (assuming earnings miraculously stay the same).

The only time that the PE Ratio has dropped as precipitously as in this bear market was in the aftermath of the 1929 bull market top. At its zenith in 1929, the PE Ratio was only approaching 33 while in the 2000 market top it reached 44.

Finally, I should mention that this isn’t necessarily the way that others calculate PE ratios – Shiller methodology smoothes out the data over 10 years to remove short term volatility.

Will Value Investors Win the Day? Wait Five Years and See.

Investors have been through this sort of meltdown twice before in the modern era: Wall Street during the 1930s, and Japan in the 1990s. What do they tell us to expect? James Montier, the great contrarian strategist at SG Securities, has run the numbers and they are fascinating.In a nutshell: If we end up like Japan, value investors are going to make money. If we end up like the Great Depression, absolutely no stock market strategy is going to work for the next couple of years.

Take the second one first. From 1929 to 1932 everything collapsed. Low-cost “value” stocks did just as badly as everything else. Ironically, profits for some companies held up well. But it didn’t help their stockholders. For three terrible years there was such massive “deleveraging” throughout the financial system that they all fell.

More on Surviving the Market
Intelligent Investor: Tempest-Tossed? Take Some ControlSunday Journal: Even ‘Value’ Investors Can’t Beat this BearBut that wasn’t the case in Japan. Sure, from 1990 to the present the overall market indices have plunged a long way. A simple index fund would have lost you, on average, about 4% a year. Fans of the index fund often subscribe to the “efficient market hypothesis,” which says you can’t beat the market. But nobody told those who followed “value” strategy in Japan in manner of Benjamin Graham and David Dodd, the authors of Security Analysis.

Mr. Montier of SG Securities found that a Japanese investor who stuck to a disciplined “value” strategy throughout the country’s 18-year bear market actually made about 3% year. The main losses on the index came from the collapse in the financials and other fallen “growth” or “glamour” stocks. As long as you avoided those, you did OK.

Investors in the kind of absolute return fund that could buy value stocks and then “short”, or bet against, so-called “growth” stocks did even better. Annualized returns from this strategy: 12% a year, even while the Nikkei plunged from 39000 to about 7200.

So, which is this: The 1930s or the 1990s?

The Great Depression was an economic cataclysm on a scale hard to imagine. U.S. industrial production halved. Prices crashed by around 10% a year for three years. Yes, disasters can happen again. Anyone who knows their history knows that lightning strikes from the blue. But economic knowledge in the 1930s was rudimentary. The government strangled the economy with prohibitive tariffs and tight money to defend the gold standard.

We may not know better these days, but we do know more. And, of course, the U.S. now matters far less than it once did in the global economy.

People talk about the financial crisis, but we really have two crises. Western consumers owe way too much money. But this is something that can usually be treated with doses of inflation, retrenchment, write-offs and bailouts (Incidentally, before we assume all consumers are broke, remember that many aren’t – and Asian consumers are loaded with cash. Perhaps, in due course, Apple will simply sell fewer laptops here and more over there).

The second crisis involves the trillions of worthless derivatives and shadow liabilities hidden within the world’s financial institutions. Watching them explode now like a series of volcanoes around the planet is both horrifying and fascinating. The mortgage crisis touched them off, but this really is a separate crisis. It is possible that the equity in financial institutions – including crypto-financials like GE and GM – will get wiped out completely and governments will be left holding trillions in worthless liabilities. They may need to print a lot of paper to cover them. Of course many of these liabilities will be offsetting.

Governments have been slow to react intelligently to this crisis. And, to reach for the top cliché of the moment, no one really knows how bad thing will get. So no one should keep all their eggs in one basket (to grab another cliché).

But this column is more interested in what is going to happen to share prices over the next five years than the next five months.

Back in 2002, at the end of the dotcom crash, I bought Amazon stock for about $12. A few years later I sold it for about $45. If that sounds good, it was. But there were times when I looked like an idiot. Soon after I bought the stock it fell as low as about $6. I had “lost” half my money. Lots of intelligent people said the company was going bust. Later, after I sold the stock for $45, it rose all the way to about $70.

We may be in a similar situation today. Investors may lose a lot of money before they make more. Yet there are now a lot of genuine “value” opportunities around. It’s true they may get cheaper yet – which supports the argument for investing slowly and dollar cost averaging. But in the words of Boston fund manager Jeremy Grantham (quoted by Mr. Montier): “If stocks look attractive and you don’t buy them and they run away, you don’t just look like an idiot, you are an idiot.”

Brett Arends