Market Discussion

[pinoleropuro]

well I hope we don't get as crazy as this guy!
the market seems like it has ruined this guy!
caution though he uses the "F" word alot!
http://www.youtube.com/watch?v=rCtQL5b_rCM

[la-onda]

fyi:

A Mixed Bag of Market Conditions

John P. Hussman, Ph.D.

A market that is becoming less reckless is typically our friend. Last week, the stock market began to more seriously price in the risk of an oncoming recession, stocks representing reasonable value generally held up well, and some of the air came out of materials stocks and industrial cyclicals. International markets were hammered on Monday, with the U.S. market closed. The hardest hit sectors globally were financials, basic resources and cyclical stocks, so there may be more difficulty for similar U.S. stocks this week. A few of the perplexingly overvalued fertilizer stocks I mentioned last week have already plunged by about 30% in just four sessions, which isn't to say that investors won't drive them back up, but at least some of the speculative pillars are actually showing some faults. If there's any hope for the Fed to do a large "inter-meeting cut," if only to put the brakes on investor panic, it will be Tuesday morning.

Investors often quote Keynes' remark that "Markets can remain irrational longer than you or I can remain solvent." But provided that investors avoid positions that could threaten their solvency, irrational markets are at worst only a periodic nuisance. Moderately irrational markets are fine for us too, since we do respond to sentiment and speculative pressures to some extent. Still, there is usually a point where the risks dominate and we step aside. As a result, we won't track the market much in strongly speculative and overvalued markets, and we won't participate much when market leadership features low-quality stocks (poor earnings stability, debt laden balance sheets, cyclical profit margins, and low barriers to entry).

It's instructive that the total return of the S&P 500 over the past 4 years has now averaged just 5.7% annually, despite the fact that the recent decline is still well short of a minimal bear market. The return on the S&P is close enough to the return on risk-free Treasury bills that our hedging over this entire period has cost us close to nothing. Equally instructive is that the S&P 500 has now lagged Treasury bills since April 1998. Valuations do indeed drive long-term market returns.

The recent bull market began at the highest valuations of any prior bull market in history. It has predictably achieved below-average overall returns, and the cycle isn't even over yet. Though every market cycle is different, an "average" bull market represents a span of about 3.75 years, with total returns averaging about 27% annually, followed by a bear market of about 1.25 years, with total returns averaging about -27% annually. That means that, on average, a typical bear market loss of just over 30% has shaved a typical bull market gain of 145% down to a cumulative return of about 65% (for a full cycle of about 5 years and overall annual total returns of about 10.6%).

The failure to understand the dynamics of market cycles is a major reason why investors repeatedly overextend their risk near market peaks, hold onto their stocks over the full course of a bear market, and finally abandon stocks near market troughs. Though less than half of a typical bull market's gains typically remain by the end of a bear market, those bear markets rarely move in a straight line. Instead, they typically include several declines of 10-20%, punctuated by very hard rallies. As I've noted before, the 2000-2002 decline, which took the S&P 500 down by nearly half, included three separate advances of about 20% each (measured from intra-day low to intra-day high). These advances serve to keep investors "holding and hoping," as Richard Russell would say.

It's important to recognize that "one-fell-swoop" market plunges typically feature rising interest rates, so even if the U.S. market follows through on the international weakness we saw on Monday, a bear market under current conditions would in all likelihood be punctuated by some powerful recoveries (though ultimately temporary - probably several weeks in duration) with additional failures later.

A mixed bag of market conditions

With regard to present market conditions, we currently observe a very mixed bag, depending on the horizon one chooses to emphasize. Over the very short term, the average stock is quite oversold, with a large proportion of stocks trading at the very lows of their trading ranges. International markets plunged on Monday, which is likely to spill over to further damage in the U.S. market. That said, it's not clear that there was not some "proxy selling" in the international markets by U.S. investors constrained by the Monday market closing. Given that, it's possible that the damage to U.S. markets may be more constrained than what we saw elsewhere.

In any event, the sort of "compression" we currently observe tends to be a setup for hard "clearing rallies," though even a lag of a few days between the initial compression and the subsequent advance can inflict a good deal of interim damage. Suffice it to say that we should soon allow for the possibility of say, a sharp 5-10% market rebound over the course of a few days or weeks, even as we maintain a predominantly hedged and defensive investment stance.

Beyond that potential for some immediate weakness followed by a solid "clearing rally," market conditions remain unfavorable overall. Valuations have come down, but remain well above historical norms (and significantly above levels that have typically marked the final trough of bear markets). The extent to which valuations look more reasonable depends on the measure one uses. On the basis of the highest level of S&P 500 earnings achieved to-date, the P/E ratio of the S&P 500 is now 15.6, which is not far from the level we observed at the 2002 low. The difficulty is that the current peak earnings figure is based on the highest profit margins in history, and implicitly embeds that assumption into the P/E multiple. Even if we assume that the multiple of 15.6 is reliable, it is no particular compliment to the market that the current multiple is similar to the one in 2002, since the overall returns we've observed since the 2002 low have been far smaller than past bull markets.

In contrast to accepting the recent level of profit margins as sustainable (as the price/peak multiple does to some extent), we can instead consider where the P/E of the S&P 500 would be if profit margins were fixed at their historical norms. In the graph below, that valuation is represented by the red line: the price/sales multiple. Note that values for the P/S multiple are on the right scale, but we can essentially read the "implied" P/E multiple off of the left scale. This is because the P/S multiple is essentially a scaled version of the P/E multiple that would exist if profit margins were fixed. At present, the P/E ratio of the S&P 500 would be about 21 if profit margins were at historical norms.

My impression is that the truth is somewhere between 15.6 and 21 (our preferred measure is at about 17.6, versus a historical norm since 1940 of about 14). In any event, valuations are still a significant distance above historical norms, and even further above levels that have represented compelling long-term buying opportunities.

Below is an updated chart of probable 10-year S&P 500 total returns based on a range of assumptions regarding terminal price/peak earnings multiples: 20 (the multiple at the 1929, 1972 and 1987 peaks),  14 (historical average), 11 (historical median) and 7 (the multiple at the 1974 and 1982 troughs). Currently, probable 10-year total returns range between extremes of -1% to +8%, with a most likely outcome between 3-5% annually.

The dark solid line tracks the actual 10-year total return of the S&P 500, which has historically been well contained within the range of projected returns except for a short-lived departure for 10-year periods that ended during the late 1990's bubble. Note that the total return for the past 10 years is at the higher band of the chart exactly because valuations are currently at the high end of historical experience. Even so, the total return of the S&P 500 for the past decade has been less than 5% annually. Suffice it to say that 10-year total returns of even 8% for the S&P 500 still represent an optimistic outlook.

Given my view that the U.S. economy has probably entered a recession, it appears fairly unlikely that the full decline in the S&P 500 will ultimately fall short of a minimal bear market decline of say, 20%. Taken from the market's recent high, that would set an initial expectation at about 1260 on the S&P 500. Of course, the average bear market has typically exceeded 30%, but I would be surprised if the market weakened below that level without producing a sustained clearing rally first.

That leaves us with a mixed bag of market conditions: major short-term compression that has a strong historical tendency to produce sharp clearing rallies, a likely recession underway that would set a 20% decline to about S&P 1260 as a likely first expectation, and gradually improving valuations that will ultimately translate into better prospects for long-term returns.

As usual, we don't need to make short-term forecasts or rely on "scenarios." Our response to ongoing market conditions is to establish investment positions in proportion to the average return/risk profile that those conditions have historically generated. We currently observe the strong potential for a furious clearing rally, possibly several weeks in duration. At the same time, I don't believe that investors have fully priced in the expectation of a recession – the possibility of one, yes, but not the expectation. Overall, the weight of the evidence demands a continued strong defense, with a willingness to establish limited "constructive edges" on market weakness, using option combinations.

Fund notes

As I discussed last week, unlike the period between 2000-2003 when our stock selection approach substantially outperformed the indices we use to hedge (consistent with our experience since the 1980's), the market's focus on low-quality "garbage stocks" in recent years has not rewarded characteristics that have generally driven stock market returns over the long term – particularly reasonably valued, stable, deliverable cash flows .

Still, unless long-term stock returns are no longer tied to valuations or cash flows, I have no reason to believe this represents anything but a temporary phase, not unlike the market's exuberance for internet stocks in the late 1990's. When the investment approach is sound, patience is usually a virtue.

I should add parenthetically that our stock selection is driven by accounting-based valuation methods and fundamental analysis, with further measurement of market action and price/volume behavior (not by the sort of kitchen sink statistical estimations that seem to be increasingly the norm among quantitative hedge funds). Data has always been our largest non-payroll expense item, because we try not to leave stones unturned or methods untested – but we vastly prefer structural present-value methods to black boxes.

Finally, in interpreting the day-to-day fluctuations of the Strategic Growth Fund, it will be helpful to remember that the Fund is managed with the intent of outperforming the S&P 500 over the complete bull-bear market cycle with smaller periodic losses than a passive investment strategy, but it is neither a bear fund nor a market-neutral fund. The Fund can, has, and will reduce the extent of its hedging in market conditions that have historically been associated with a favorable return/risk profile. Meanwhile, the most defensive stance taken by the Fund is a fully hedged position, so even if stocks are in a bear market, shareholders should generally not assume that the Fund's returns will be driven primarily by the market's losses.

Indeed, during the turbulent period from 2000 through mid-2003, there were nearly as many up months for the S&P 500 as there were down months, though the down months were more hostile. Even so, the average total return of the Fund during those up months for the S&P 500 was not far from the average return of the Fund during the down months (1.3% vs. 1.6%). In other words, the Fund's performance over periods of a few weeks or more was relatively independent of market direction, as intended. As always, Fund returns can be either positive or negative depending on how our stock holdings perform relative to the indices we use to hedge. The difference in performance between our stocks and those indices has been the main source of Fund returns since inception. In any case, I can't stress enough that the Fund does not establish "bearish" net short positions that would predictably experience large or sustained losses if the market was to advance, nor explosive gains if the market was to decline. The Fund is not net short, and is not positioned to behave as a "bear fund." The Strategic Growth Fund is best considered to be a risk-managed long-term growth fund.

Market Climate

As of last week, the Market Climate for stocks was characterized by moderately unfavorable valuations (see the discussion above) and mixed market action (increasingly favorable short-term "compression" as the market declines, but otherwise unfavorable conditions). The Strategic Growth Fund remains predominantly hedged and defensively positioned against major market losses, but with modest positions (primarily using option combinations) that would "soften" our hedge in the event of a near-term advance. The next few weeks promise to be extremely volatile, so it is preferable not to seek excessive meaning in day-to-day returns, which will be heavily affected by exactly which sectors experience strength or weakness on any given day. We're defensively positioned and I view our stock holdings as being broadly undervalued relative to the indices we use to hedge, so I expect to weather continued market weakness if it emerges (though possibly with a few short-term losses as well, since again, the Fund does not carry a net short position). We do carry various underweights and overweights in various sectors, which may experience more or less day-to-day fluctuation than the major indices.

In bonds, the Market Climate was characterized by unfavorable yield levels but moderately favorable yield trends. Overall, the Strategic Total Return Fund currently carries a duration of about 2 years, mostly in TIPS. Meanwhile, gold stock prices dipped relative to the metal, driving the gold/XAU ratio over 5.0. Similar levels have historically been followed by very strong returns, particularly when U.S. interest rates are falling, inflation pressures persist, and U.S. economic growth is slowing. Downward pressure on real interest rates and by extension, the U.S. dollar, is generally followed by strong returns in precious metals shares. Accordingly, I used the recent price weakness in precious metals shares to bump the exposure of the Strategic Total Return Fund back toward 24% invested in that group. 

with graphs:
http://www.hussman.net/wmc/wmc080121.htm

[la-onda]

ShadowTraderPro Focus Report for January 22, 2008

The Big Picture


Good Morning, Traders. As of this writing at 7pm EST on Monday night (1/21), S&P futures are down 53.75 points and Nasdaq futures are down 69.50. This means that without Fed intervention (or some other catalyst that would have the propensity to reverse these losses) between now and 9:30am tomorrow, the markets are going to open much, much lower. This will be the mother of all gap downs if the situation does not improve between now and then. The SPX should open somewhere well below 1300 in the 1260-1270 area. Given this situation, there is very little we can say here as to what will happen in the bigger picture.

If the aforementioned catalyst does not appear then we can be relatively sure of one of three scenarios playing out. One is that the market will open 50+ points lower and rally immediately. If that happens then we would see the market probably remain strong all day. The second option would be that the market opens much lower and sells off right from the open and continues to sell all day long, taking the spx down by at least 80 by the close. In this option, the market might not fall immediately at the open but would more than likely move below first 15 minute and first 30 minute lows which would set the tone for the rest of the day. The third option would be that the market would open much lower and use most of the morning and lunchtime to digest the gap down, going sideways for the morning session and then sell off harder in the afternoon. These are the three scenarios that we feel have the highest probability of happening tomorrow. Note that just chopping around, ie: going up a bit then down a bit are probably not happening. There is too much emotion out there. Therefore, people are either going to all panic en masse immediately (option 2), panic only a little then full on Armageddon later as they realize that sideways after a 50 point gap down is not bullish (option 3), or the whole world is going to see bargains in front of their eyes and there will be massive short covering on the open (option 1). Those of you who are reading this and are long stocks (or short vertical put spreads), please make a mental note of what you do tomorrow and then realize that probably all of the retail money in the world is going to do the exact same thing. This is because human nature is human nature and people are people. Everyone is going to pretty much act the same way.

So, what are some clues as to which scenario is going to play out? The market internals of course. There will be a breadth reading and an advance decline reading and a trin reading. The way these indicators react to the open and are trending both in the first 15, 30 and 60 minutes of trade will be key in figuring out sentiment and direction. If these numbers open up rather benign, then we could see rally. If these numbers are very bearish from the open and make no effort to improve, ie: breadth worse than 10:1 negative on open, A/D lines opening up -2000 or worse, trin over say 4.0, then the selling will probably continue. Remember that whatever you think is oversold or overdone can always become more overdone. The last panic situation that we had was almost a year ago on 2/27/07. Anyone remember that? Breadth (the relationship between up volume and down volume) was 100:1 negative on that day. Yes, 100 to 1. You read that correctly. On that day the SPX gapped down 20 points and then sold off about 30 more, ending the day down about 50. As of now we are going to just gap down that much at the open. Should be interesting.....

Please take a moment to read the user's guide of this newsletter and re-read the gap rules which can give you an objective viewpoint on what to do when stocks gap down past your stops. We strongly feel that if you apply these principles it will take a lot of the emotion out of the action and you will be acting according to a plan and not reacting in a knee-jerk manner. We would also like to point out to everyone, especially those of you new to this letter that the ShadowTraderPro Model Portfolio is not long at all except for the 100 shares of GLD (gold). We are not short either but honestly that does not bother us one bit. Our p&l is strongly positive and the market is going to finish q1 '08 down huge. Many other swing trading newsletters and advisories will be out of business after tomorrow. The market was already pretty oversold coming into this gap, so we feel pretty good that we did not chase shorts down. Nobody could ever have foreseen the amount of gap down that is about to happen, we only knew that little by little over the last month or so, leading stocks started to crumble and many of our long plays ended up being situations where we had to dump break-even or get stopped out because breakouts just failed. Note that the last position we took which was a long in IVGN on 1/17, only ran up for one day and then failed miserably the next. We only took half size on that play. Let's just say we had a feeling.......Cash is king and the best bet is to sit this out. Gold should remain strong after a further shakeout and we'll probably add to our position if so. There will be opportunities in '08 and we'll continue to find them for you as we have done since inception. Best of trades to you all on this eve of destruction......


Under The Hood
When we say "under the hood" we mean market internals, ie: what was really happening behind the scenes. ShadowTraders who listen to our daily broadcast every day live on the thinkorswim platform know that all closing figures on the major averages should only be interpreted in the context of market internals. Look for convergences and divergences in the breadth, a/d line, and trin figures below to either confirm or cast doubt on what all those talking heads on TV are telling you.

Dow Jones Industrial Average    12,099.30    -59.91    -0.49%
S&P 500    1,325.19    -8.09    -0.61%
Nasdaq Composite    2,340.02    -6.88    -0.29%
Nasdaq 100    1,844.09    +1.99    +0.11%
Russell 2000    673.18    -7.65    -1.12%
Spot Gold    $881.70/oz.    -1.20    -0.14%
Crude Oil    $89.92/bbl.    -0.21    -0.23%
NYSE Overall Volume    2,455,250K    n/a    +19%
Nasdaq Overall Volume    2,986,550K    n/a    +17%
NYSE Breadth    1.4 : 1    negative    
Nasdaq Breadth    1.8 : 1    negative    
NYSE Breadth Ratio    7.56       
Nasdaq Breadth Ratio    20.61       
NYSE Advancers/Decliners    -845       
Nasdaq Advancers/Decliners    -813       
NYSE Trin    .84       
NASDAQ Trin    1.03       
$VIX    27.18    -1.28    
Strongest Groups:    Semiconductors    Amex Oil    Transports
Weakest Groups:    Insurance    Biotechs    Banking

Heads Up
Up and coming economic and corporate data that may move markets this week:

Today
    10:00am EST - State Street Investor Confidence Index
    Reporting earnings before the open: AKS, BAC, DD, JNJ, LM, SLG, UNH, WB
    After the close: AAPL, TXN
Wednesday
    10:30am EST - Crude Inventories
    Reporting earnings before the open: ATI, COH, COP, DAL, GD, MOT, PFE, ROK, LUV, STI, UTX, WLP
    After the close: COF, EBAY, FFIV, GILD, NFLX, NE, QCOM
Thursday
    08:30am EST - Jobless Claims
    10:00am EST - Existing Home Sales
    Reporting earnings before the open: T, CBE, F, IMCL, LEN, LMT, NOK, NUE, POT, SPWR, TXT, UNP
    After the close: AMGN, BRCM, DV, ETFC, KLAC, MSFT, PCU

[David Randolph]

Gee, even the FED panicked today:

Fed cuts interest rates by 75 basis points

I'm still not sure what to think of this, I certainly don't like to see the FED being pushed by the market or politicians to take action. But this is Bernanke's style, he may even send the helicopter out ...

[David Randolph]

Gee, even the FED panicked today:

Fed cuts interest rates by 75 basis points

I'm still not sure what to think of this, I certainly don't like to see the FED being pushed by the market or politicians to take action. But this is Bernanke's style, he may even send the helicopter out ...

On a second thought I think the FED may very well have the solution to the current crisis, which is a liquidity crisis.

Because, if the problem comes from consumers not being able to pay for their mortgages and credit cards and banks having huge losses ... the important thing here is time. I say time because eventually consumers will pay or be forced to pay, with interest and penalties.

What banks need is time and capital at a low price (low interest rate) to navigate through the storm while they're after consumers to get their money back.

My view is we're going through a conjectural crisis, not a structural one, pretty much like the 1990/91 recession.

We'll see what the future brings, these are interesting times.

[stocky]

Fed is stroking inflation by cutting interest rates. Making the paychecks lighter and what that mean is that consumer will have less spending power. Exactly what the Fed want to do. Heck, this is not a solution. This is a problem.

[stocky]

I think we should have charts in inflation adjusted basis to really know whether they are going actually up or we are fooled by the increase due to reverse split of dollar. Time to buy inflation resistant assets like home, gold and grains.

[usedcasting]

I guess it all comes down to whether you are believer in US economic policy. I am not. The ice is thin and the zamboni is running out of water.

uc.

[buddjas1]

I suggest reading Bernanke's 1983 article on the causes of the Great Depression.  Ben S. Bernanke, Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression, The American Economic Review, Vol. 73, No. 3. (Jun., 1983), pp. 257-276.

To him, the GD was a consequence of "the loss of confidence in financial institutions, primarily commercial banks and the widespread insolvency of debtors." 

Sound familiar?

[kslifka]

The S&P just tagged....A very long trend line going back to the lows of 1981 hitting the lows of 2002.  I drew this on a log scale.   A "less" steep trendline going back to 1984...bisects 1220 on the S&P.(which by the way was the low in June 2006.)

For what it's worth.

[tokyopua]

If ever there was a good time for the Fed to come in with a rate cut before their scheduled meeting, now would be the time!  Anything above 50 basis points tomorrow could help, and a full percentage rate cut could actually neutralize or even rally the market.  Doubt it will happen, but thats our best hope for tomorrow at this point.

Didnt think they would do it, but I would hate to have seen how bad today would have been without the rate cut.  I dont disagree with it, I think they planned a cut in a week anyway, and now it has more teeth to do it today.

[mbaugh]

Looks like all the major indexes could form a V-bottom if we continue higher tomorrow.  This could speed the recovery and provide for a nice rally that could last for several months.  It seems like on Wall Street problems happen overnight and problems get fixed overnight.  What a crazy world!

[BigSully1]

 read.

http://www.minyanville.com/articles/index/a/15610/from/yahoo

[la-onda]

fyi from IV:

Old Fool Notes – 01/22/08
An interesting day today.  The bulls recovered from a stiff slap down at the open to achieve a decent but not spactacular recovery.  That's good because a green close would have raised a bunch of eyebrows and attracted the bears big time.  The volume was 3.1 billion with a ratio of 4 to 1 in favor of the bears.  That is not an efficient ratio considering the initial gap down.  Bears blew a bunch of money holding it down.

The daily chart looks totally abysmal – and that's good.  Nothing more to say.

The hourly chart shows the action today very clearly.  It also shows the wall that the bears have erected at 2300.  That's an important level for tomorrow.

The ratio chart continues to reflect the option boy's worry.  This is exactly why the bulls should take it easy.  As long as the bulls push easy, the option guys will go along with the game.  Not a bad chart.

The weekly chart is horribly oversold.  We also broke through long standing support.  At this stage of the game, I believe that is good and will get some attention from the buyers.  It has mine.

The Wilshire staged a strong push back – much better than the Naz.  That is also good.  I like to see the small fry lead the charge.

The P&F got plowed under but is awaiting about 6 Xs in return.  The strength of the down move is very evident in this chart as is the short time it took.  We will see but those short term moves usually do not hold.

I had several trades today in both the LT and trading port.  I also broke one of my trading rules to not trade before 10am.  The Fed cut before open changed that rule.  What happens with surprise news is that a bunch of folks have sell/buy orders all lined up before the open and they execute at the open.  The pros then step in – almost a certainty.  So I was buying about 10 minutes in today.  I bought QLD as a day trade in the TP.  I also bought INTC, XLF, TE and several other interesting stocks for the LT port. Added a few mutual fund buys late.  The QLD is gone and back to 100% cash in the TP.  I am just nibbling along for the LT port.  No need to look for the bottom – plenty of time.  Speaking of a bottom – I still have several of my bottoming indicators that are still dropping but others that edged up today.  Good enough for more nibbling.  2300 is important and so is 2225.  Keep an eye on them.

Charts link below – thanks much for the votes over at SC.  You guys keep it up and I may get another $25 credit – LOL

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID2071209

Have a good evening and stay on your toes.

The Old Fool

[tokyopua]

hang Seng index up 10.72% as I type this, holy moly! 

I have Etrade Global, though I have never used it to trade stocks in Hong Kong.  Wish I had put some Hong Kong dollars in that account and bought up a truck load of Hong Kong stocks before today haha, I bet almost every stock is UP UP UP on a up 11% day, I am just imagining what it would be like to see a day in the S&P up 11% 

Anyway, Asia in general looks to be bouncing back a bit, maybe we will get the v-bottom after all.