Yesterday, Friday morning, October 24, I awoke with the news that the S&P 500 Index Future had traded at a 5% preopening limit down, with the Asian markets having closed down 8-10% for their trading day. My immediate thought was "Fasten your seatbelts! We are going to test the October l0 lows!"
In my October 16 posting entitled "Puking Redux", I discussed the criteria I analyze to determine if a retest of a major low is successful. In order of importance -- breadth (number of new 52 week lows), volume, and price. At the end of trading yesterday, here are the comparisons with October 10, the recent "capitulation" day:
October 10 October 24
Number of 52 week new lows: 2901 1125
Composite volume: 11.2 billion 6.5 billion
Intra-day low price 840 853
Closing price 900 877
While yesterday's intra-day low was within 2% of the low on October 10, the number of new lows was less than 40% of the new lows on October 10. This reinforces the notion that a breadth climax occurred on October 10. Furthermore, the volume yesterday was less than 60% of the volume on October 10--evidence of a volume climax as well on that date. The pricing was mixed, with a lower closing price yesterday but a lower intra-day price on October 10. However, pricing is the least important criteria of gauging a successful test. My conclusion is that yesterday's test was, indeed, successful.
To be sure, none of this rules out further tests in the future. After all, the percentage bears, at 54.4% last Wednesday, hasn't yet reached the threshold 60% level I consider very important. Also, disconcerting are the rumors that some very large hedge funds are in trouble.
With respect to the monies I have earmarked for equities, I am now five-sixths invested. Unless Monday's action indicates another test, I shall complete my buying program then.
I am reminded of the story about the man who jumps from a skyscraper and at each floor is heard yelling "Everything is all right so far!" At the end of each trading day, I feel like that guy!
Saturday, October 25, 2008
Tuesday, October 21, 2008
An Epiphany--Maybe
On last Saturday, October 18, Joe Nocera's article called "Shouldn't We Rescue Housing?" appeared in The New York Times. After reading it, I had what may have been an epiphany--which Webster's Dictionary defines as "an intuitive grasp of reality through something usually simple and striking." I say "may have been" because, in order to have been an epiphany, the future reality has to be confirming.
As the title indicates, Nocera argues that the next rescue effort should be concentrated on stabilizing home prices. I strongly agree. After all, the bursting of the home price bubble is the central cause of the credit crisis and recession. And if the slide in home prices and the buildup of unsold home inventories continue unchecked, the result will be a further vicious cycle of lower home prices, more delinquent mortgages, and more foreclosures leading to lower home prices.... This would prolong and deepen the recession.
It doesn't take a "phi beta kappa" to figure this out. So why hasn't this already been done? First of all, the more immediate problem facing our economy as recently as October 10 (it seems like ages ago) was a freezing up of the credit flows necessary for commerce to flourish in this country. Unless action were taken quickly, our economy and the remainder of the world to boot would probably have lapsed into a depression. I wrote about this in my October 12 posting "Scared Straight." Now, after the rescue efforts by Treasury, the Federal Reserve and Congress, the flow of credit seems to be at least partially restored as evidenced by the decline in the three month Libor rate.
The second reason why we haven't heard a lot about rescuing housing is the upcoming election. In dealings with my local government, I learned long ago that there can be a vast difference between "reality" and "political reality." "Reality" is something should be done to rescue housing. "Political reality," all about votes, is how will any housing rescue plan affect the imminent election?
Nocera writes "there are lots of Americans who were not greedy or foolish during the housing bubble, and many resent the idea that their neighbors might get a bailout they don't deserve." From a political point of view, that potential for resentment weighs heavily in the decision whether to act now or after the election. After all, the number of homeowners without mortgages and the 96% of mortgagees who are current on their payments dwarf the number of people delinquent on their mortgages. The ratio is more than 24 to one. So why risk the wrath and votes of at least 24 homeowners to win the vote of one?
I believe that, immediately after the election, the president-elect will propose a major, effective housing rescue plan. By the end of the year, that plan should become law.
How does this affect my view of the equities market? It increases the probability that the S&P 500 Index's intra-day low of 840 on October 10 will mark the low of this bear market. At the very least, any serious test of that low should be later rather than sooner. With this in mind, yesterday I added more to my equity position by purchasing shares in the T. Rowe Price New Asia Fund. This fund has roughly 40% of its capital in China, 30% in India and the remainder in other Asian emerging economies. Its price range has been a low of $3.92 in 1998 and a high of $22.06 in
2007. From the 1998 low to yesterday's closing price of $8.70, the fund has appreciated at a compound 8.3% annual rate, less than the weighted-average real growth of the portfolio's underlying economies. Last year, there was a huge influx of foreign money into this fund due to the much higher real growth rate in Asia and the theory that there is a decoupling between the U.S. economy and the Asian economies. The decoupling theory has been discredited, and U.S. investors, due to the greater decline in the Asian markets than here, have been redeeming shares. It seems like a good entry point. There is the risk that China's booming economy is overseen by a Communist government. I regard this fund as a high growth, high risk investment. When I am fully invested in equities, 75% will be in an S&P 500 Index fund and 25% in this Asian fund.
As the title indicates, Nocera argues that the next rescue effort should be concentrated on stabilizing home prices. I strongly agree. After all, the bursting of the home price bubble is the central cause of the credit crisis and recession. And if the slide in home prices and the buildup of unsold home inventories continue unchecked, the result will be a further vicious cycle of lower home prices, more delinquent mortgages, and more foreclosures leading to lower home prices.... This would prolong and deepen the recession.
It doesn't take a "phi beta kappa" to figure this out. So why hasn't this already been done? First of all, the more immediate problem facing our economy as recently as October 10 (it seems like ages ago) was a freezing up of the credit flows necessary for commerce to flourish in this country. Unless action were taken quickly, our economy and the remainder of the world to boot would probably have lapsed into a depression. I wrote about this in my October 12 posting "Scared Straight." Now, after the rescue efforts by Treasury, the Federal Reserve and Congress, the flow of credit seems to be at least partially restored as evidenced by the decline in the three month Libor rate.
The second reason why we haven't heard a lot about rescuing housing is the upcoming election. In dealings with my local government, I learned long ago that there can be a vast difference between "reality" and "political reality." "Reality" is something should be done to rescue housing. "Political reality," all about votes, is how will any housing rescue plan affect the imminent election?
Nocera writes "there are lots of Americans who were not greedy or foolish during the housing bubble, and many resent the idea that their neighbors might get a bailout they don't deserve." From a political point of view, that potential for resentment weighs heavily in the decision whether to act now or after the election. After all, the number of homeowners without mortgages and the 96% of mortgagees who are current on their payments dwarf the number of people delinquent on their mortgages. The ratio is more than 24 to one. So why risk the wrath and votes of at least 24 homeowners to win the vote of one?
I believe that, immediately after the election, the president-elect will propose a major, effective housing rescue plan. By the end of the year, that plan should become law.
How does this affect my view of the equities market? It increases the probability that the S&P 500 Index's intra-day low of 840 on October 10 will mark the low of this bear market. At the very least, any serious test of that low should be later rather than sooner. With this in mind, yesterday I added more to my equity position by purchasing shares in the T. Rowe Price New Asia Fund. This fund has roughly 40% of its capital in China, 30% in India and the remainder in other Asian emerging economies. Its price range has been a low of $3.92 in 1998 and a high of $22.06 in
2007. From the 1998 low to yesterday's closing price of $8.70, the fund has appreciated at a compound 8.3% annual rate, less than the weighted-average real growth of the portfolio's underlying economies. Last year, there was a huge influx of foreign money into this fund due to the much higher real growth rate in Asia and the theory that there is a decoupling between the U.S. economy and the Asian economies. The decoupling theory has been discredited, and U.S. investors, due to the greater decline in the Asian markets than here, have been redeeming shares. It seems like a good entry point. There is the risk that China's booming economy is overseen by a Communist government. I regard this fund as a high growth, high risk investment. When I am fully invested in equities, 75% will be in an S&P 500 Index fund and 25% in this Asian fund.
Thursday, October 16, 2008
Puking Redux
In my last posting entitled "Entering the Puking Phase", I indicated that the market's behavior on Friday, October 10, may have been a capitulation -- signaling the end of this vicious bear market. However, I only put to work one third of the remaining funds allocated to equities, at a price of 900 in the S&P 500 Index(the Index). That is because I wanted to wait until the following Monday or Tuesday before committing the rest. Only major news out of last weekend's world leader meetings could disturb this climatic process. Major headway toward restabilizing the flow of monies throughout the financial system was announced, and the equity markets around the world erupted to the upside.
I applaud the moves last weekend. They are necessary to restore the flow of credit throughout the global financial system. The three month Libor rate, a barometer of fear in the credit markets, has started to come down to more normal levels--a good thing. The restabilizing of the credit markets will allow the U.S. economy to avoid a depression, but we are still faced with a prolonged recession, which I contend started in December, 2007, and will continue through mid to late 2009. Afterall last year's vast erosion of financial assets was caused by the decline in home prices. So far, there has been little governmental intervention to hasten the normalizing of the homes-for-sale inventory, which would alleviate the downward trend in home prices. The government may take action to accelerate this normalizing process, which would spark a significant equities rally.
The low in the S&P 500 Index on October 10 was 840 intraday and 900 at the close. During most bottom processes, there is a test of these levels. A successful test would allow me to invest the remainder of monies allocated to equities.
What constitutes a successful test? In order of importance: (1) breadth of the market (number of new lows for the year),(2) volume, and (3) price. Price is the least important because we have experienced major bottoms wherein slightly lower prices for the Index were reached during the test, yet the breadth and volume were more favorable, which signaled that the original bottom was really THE BOTTOM for most equities. On October 10, the number of new NYSE lows for the year was 2901 out of a total 3335 issues, a rare event indeed. NYSE composite volume was 11.2 billion shares, almost twice the average for the last several months. We should compare these levels with those occurring when and if the Index revisits 840.
Now for a mea culpa. The percentage bears from Investors Intelligence yesterday showed no movement upward from the previous Wednesday. (Actually at 52.9%, it was a smidgen below the previous 53%.) To put it mildly, I view that as counterintuitive. Afterall, the Index had one of its worst ever downdrafts during the previous week. It was my understanding that I.I. called the more than 100 investment advisors each Friday for their market opinions, tabulated the results during the next two business days, and published the results on Wednesday. I called the service and discovered that the procedure was different. I.I. subscribes to the advisory letters or emails and compiles the numbers on Tuesday night for publication on Wednesday. So some advisors who were turning bearish might have changed their minds after Monday's rally. If so, and if the Index is in the process of testing last Friday's low, the percentage bears should increase when the number is published next Wednesday.
A good money management approach is to analyze each investment according to an expected return-to-risk ratio. During my money management career, I found a ratio of three-to-one to be about as attractive as I could find. What was that ratio when the Index hit its low of 840 last Friday? The upside potential is roughly 1565, which may take five or six years to reach. That would be at roughly the two highs of the bull markets that ended in 2000 and 2007, which constitutes a massive double top.
The low is difficult to ascertain. From a technical point of view, perhaps we should look at the trendline for the Index from the two most important bottoms during my adult lifetime, 1974 and 1982. After all, if we are witnessing a deleveraging of the economy back to the days of more normal leverage, perhaps the preleveraging trendline is appropriate. That trendline is now at roughly 600.
What could take us down to that level? If the supply of money is plentiful BUT the demand for it isn't there, the resulting recession would be horrendous. This is what is known as the dreaded "liquidity trap" or "pushing on a string".
The earnings of the Index under those circumstances would possibly be in the 45 area, down from the high 80s at the top. That would take into consideration (1) a reversion to the normal profit margin of 8% from the inflated 13% at the high and 2) an adjustment from that level to account for the recession. The indicated dividend for the Index, which topped at over 29, would probably decline to the mid-twenties. At 600, the Index would be selling for around 13 times earnings and yielding 4%, a very attractive level historically, especially given the 2-2.5% core inflation rate.
If this estimate of reward at 1565 and risk down to 600 is assumed, then the upside at 840 is 725 points and the downside 240, for roughly a three-to-one ratio. You might ask if 1565 is more probable than 600 during the next six years? This may sound strange, but I think so.
I applaud the moves last weekend. They are necessary to restore the flow of credit throughout the global financial system. The three month Libor rate, a barometer of fear in the credit markets, has started to come down to more normal levels--a good thing. The restabilizing of the credit markets will allow the U.S. economy to avoid a depression, but we are still faced with a prolonged recession, which I contend started in December, 2007, and will continue through mid to late 2009. Afterall last year's vast erosion of financial assets was caused by the decline in home prices. So far, there has been little governmental intervention to hasten the normalizing of the homes-for-sale inventory, which would alleviate the downward trend in home prices. The government may take action to accelerate this normalizing process, which would spark a significant equities rally.
The low in the S&P 500 Index on October 10 was 840 intraday and 900 at the close. During most bottom processes, there is a test of these levels. A successful test would allow me to invest the remainder of monies allocated to equities.
What constitutes a successful test? In order of importance: (1) breadth of the market (number of new lows for the year),(2) volume, and (3) price. Price is the least important because we have experienced major bottoms wherein slightly lower prices for the Index were reached during the test, yet the breadth and volume were more favorable, which signaled that the original bottom was really THE BOTTOM for most equities. On October 10, the number of new NYSE lows for the year was 2901 out of a total 3335 issues, a rare event indeed. NYSE composite volume was 11.2 billion shares, almost twice the average for the last several months. We should compare these levels with those occurring when and if the Index revisits 840.
Now for a mea culpa. The percentage bears from Investors Intelligence yesterday showed no movement upward from the previous Wednesday. (Actually at 52.9%, it was a smidgen below the previous 53%.) To put it mildly, I view that as counterintuitive. Afterall, the Index had one of its worst ever downdrafts during the previous week. It was my understanding that I.I. called the more than 100 investment advisors each Friday for their market opinions, tabulated the results during the next two business days, and published the results on Wednesday. I called the service and discovered that the procedure was different. I.I. subscribes to the advisory letters or emails and compiles the numbers on Tuesday night for publication on Wednesday. So some advisors who were turning bearish might have changed their minds after Monday's rally. If so, and if the Index is in the process of testing last Friday's low, the percentage bears should increase when the number is published next Wednesday.
A good money management approach is to analyze each investment according to an expected return-to-risk ratio. During my money management career, I found a ratio of three-to-one to be about as attractive as I could find. What was that ratio when the Index hit its low of 840 last Friday? The upside potential is roughly 1565, which may take five or six years to reach. That would be at roughly the two highs of the bull markets that ended in 2000 and 2007, which constitutes a massive double top.
The low is difficult to ascertain. From a technical point of view, perhaps we should look at the trendline for the Index from the two most important bottoms during my adult lifetime, 1974 and 1982. After all, if we are witnessing a deleveraging of the economy back to the days of more normal leverage, perhaps the preleveraging trendline is appropriate. That trendline is now at roughly 600.
What could take us down to that level? If the supply of money is plentiful BUT the demand for it isn't there, the resulting recession would be horrendous. This is what is known as the dreaded "liquidity trap" or "pushing on a string".
The earnings of the Index under those circumstances would possibly be in the 45 area, down from the high 80s at the top. That would take into consideration (1) a reversion to the normal profit margin of 8% from the inflated 13% at the high and 2) an adjustment from that level to account for the recession. The indicated dividend for the Index, which topped at over 29, would probably decline to the mid-twenties. At 600, the Index would be selling for around 13 times earnings and yielding 4%, a very attractive level historically, especially given the 2-2.5% core inflation rate.
If this estimate of reward at 1565 and risk down to 600 is assumed, then the upside at 840 is 725 points and the downside 240, for roughly a three-to-one ratio. You might ask if 1565 is more probable than 600 during the next six years? This may sound strange, but I think so.
Sunday, October 12, 2008
Entering the Puking Phase
Those of you who have been reading my previous postings since I began Pywrite in March, 2007 have been bombarded by my notion that psychology, not logic, is the better way to discern bear market bottoms. In other words, at bear market lows, a sentiment indicator of fear tends to be a coincident indicator while the economic fundamentals tend to lag.
Sentiment indicators are contrary indicators in the sense that a very high level of bearishness is a positive sign. Once the percentage bearish exceeds a threshold level last seen at previous bear market lows, the market tends to be at an attractive buying level. Investors Intelligence weekly questions investment advisors as to their feelings about the market and categorizes them as bearish, bullish, or bullish but awaiting a correction. In the past, when the level of outright bears reached 60% of advisors, that, in hindsight, proved to be a buy point. The percentage bears reached 53% in the latest published reading, but that sentiment didn't include last week's horrific decline. Unfortunately,the next reading will be published Wednesday and will represent the sentiment as of last Friday. While a rise from 53 to 60 would be a rare event in one week, last week's market action was the rarest of events. So there is the possibility that the 60 level was reached, but we won't know about that until midweek.
Another indicator of extreme fear is what is known variously as a "capitulation phase", a "selling climax", or a "puking phase". That occurs at the end of an exhausting bear market, when customers call their brokers and say, "I WANT OUT! I DON'T CARE AT WHAT PRICE!" Those occur very infrequently. They are characterized by 1) a violent downdraft in the morning, followed by a rally that takes the market at or near its previous day's close; and 2) very heavy volume. Friday's action resembled such an event. However, the volume, while very heavy, probably should have been higher, and this happened on a Friday. Rarely does a bear market end on a Friday because investors have the weekend to absorb the terrible news from the previous week and tend to panic on a Monday or Tuesday. A mitigating circumstance would be some very positive news emerging from the meetings among world leaders this weekend. Absent that, there could be climatic action on Monday or Tuesday.
As indicated in previous postings, I have been waiting until either a "puking phase" or a sentiment indicator of 60% bears before committing more money to equities. Friday's action sufficiently resembled climatic action to warrant putting to work some, but not all, of the remaining money held in reserve for equity investment. Accordingly, I invested one-third of that money in a Standard and Poor's 500 Index Fund at Friday's closing price of 900 in the Index. The remainder may be invested as early as next Monday or Tuesday.
Sometime in the near future, I will discuss what the market is discounting at a level of 900 in the Index, and what the upside potential and downside risk are at that level.
Sentiment indicators are contrary indicators in the sense that a very high level of bearishness is a positive sign. Once the percentage bearish exceeds a threshold level last seen at previous bear market lows, the market tends to be at an attractive buying level. Investors Intelligence weekly questions investment advisors as to their feelings about the market and categorizes them as bearish, bullish, or bullish but awaiting a correction. In the past, when the level of outright bears reached 60% of advisors, that, in hindsight, proved to be a buy point. The percentage bears reached 53% in the latest published reading, but that sentiment didn't include last week's horrific decline. Unfortunately,the next reading will be published Wednesday and will represent the sentiment as of last Friday. While a rise from 53 to 60 would be a rare event in one week, last week's market action was the rarest of events. So there is the possibility that the 60 level was reached, but we won't know about that until midweek.
Another indicator of extreme fear is what is known variously as a "capitulation phase", a "selling climax", or a "puking phase". That occurs at the end of an exhausting bear market, when customers call their brokers and say, "I WANT OUT! I DON'T CARE AT WHAT PRICE!" Those occur very infrequently. They are characterized by 1) a violent downdraft in the morning, followed by a rally that takes the market at or near its previous day's close; and 2) very heavy volume. Friday's action resembled such an event. However, the volume, while very heavy, probably should have been higher, and this happened on a Friday. Rarely does a bear market end on a Friday because investors have the weekend to absorb the terrible news from the previous week and tend to panic on a Monday or Tuesday. A mitigating circumstance would be some very positive news emerging from the meetings among world leaders this weekend. Absent that, there could be climatic action on Monday or Tuesday.
As indicated in previous postings, I have been waiting until either a "puking phase" or a sentiment indicator of 60% bears before committing more money to equities. Friday's action sufficiently resembled climatic action to warrant putting to work some, but not all, of the remaining money held in reserve for equity investment. Accordingly, I invested one-third of that money in a Standard and Poor's 500 Index Fund at Friday's closing price of 900 in the Index. The remainder may be invested as early as next Monday or Tuesday.
Sometime in the near future, I will discuss what the market is discounting at a level of 900 in the Index, and what the upside potential and downside risk are at that level.
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