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02/25/2009
- Tuesday's Big Gains Lacked Upside Volume: Trends can help us
understand the collective perceptions of investors, which ultimately drive
asset prices (see charts below).
Fundamental
Changes Not Behind Tuesday's Rally: What appeared to
have sparked yesterday's rally?
·
Ben Bernanke on Economy: "If
actions taken by the administration, the Congress and the Federal Reserve are
successful in restoring some measure of financial stability -- and only if
that is the case, in my view -- there is a reasonable prospect that the
current recession will end in 2009".
·
Bernanke on Banks: "We don't need majority
ownership to work with the banks." I guess this means we will have
slow and partial nationalization of the banks instead of "full"
nationalization. Either way, it dilutes the current stockholders and means
the U.S. government, either directly or indirectly, will have major influence
and power over the banking system. Based on the government's track record of
running anything (e.g., Medicare, Social Security, Federal budget, Fannie
Mae, the Fed, etc.), I do not see this as a positive for the economy, free
markets, or investors. The government has been "assisting" banks
for roughly a year now. Has it really helped? So far the bailouts have
reminded me of "zombie banks" and Japan's "lost decade". How
long will the government be in the banking business? My guess is a lot longer
than most people think.
·
Valuations: Lower valuations do not guarantee a market
bottom as pure value investors have found numerous times over the last year. If
we use very reasonable normalized earnings and PE multiples found at the
1974-1975 bear market bottom, the S&P 500 could realistically fall to
around 525 before the market bottoms. If you are buying solely because the
market is "cheap" or "near a bottom", keep in mind the
525 figure is based on actual historical valuations. We are not
forecasting 525 on the S&P 500. We are just trying to understand how
low valuations may get before investors feel compelled to step in and buy. To
reach "worst-case bear market bottom valuations" the S&P 500
would need to fall 32% from Tuesday's close. If you lose 32%, you will need
to make 47% just to be back to break even. For example, if I hold between 768
and 525 on the S&P 500, I will lose 31.6%. A 31.6% loss on $100,000 would
leave me with $68,400. If I gain 47% on $68,400, I would earn $32,148. $68,400 + $32,148 =
$100,548 (back to break even).
·
Range Traders: Range traders are just that
"traders". They are not long-term investors. They try to profit
from buying at the low end of a trading range and selling at the top of the
range. We are at the low end of a trading range that began in October 2008. Range
traders may have no intention of holding for the long-term, which means their
buying pressure will be converted to selling pressure in the future. Yesterday's
volume looks like bargain hunting and range traders stepping in - it does not
look like the beginning of a new bull market. Could stocks rally from here?
Yes. Could yesterday have been the end of the bear market? Not likely, but if
we see observable evidence to signal a significant change in trend, then we
will consider putting more capital at risk. We need to see more. We need to
remain patient for now. If you waited for clear signs of a trend change after
the 2000-2003 bear market, you would have invested more aggressively (and
with more confidence between May 1, 2003 and May 14, 2003). The S&P 500
still increased roughly 69% from the May 14th closing price to the bull market
high in 2007 - a great return with a good risk/reward profile (much better
than today's risk/reward profile). Since we sold early and protected our
principal, we have the luxury of being patient. Even if you did not sell
early, we remain in a bear market and protecting principal is still very
important as illustrated by the 32% loss / 47% gain example above.
The
charts below put some context around yesterday's moves in both stocks and
gold. How a long-term investor and a trader interpret yesterday's moves may
be quite different. For investors, gold still looks attractive and stocks
remain unattractive.
Volume
can help us better understand investor's demand for or confidence in stocks. When
investors are confident, stock market gains occur on strong volume.
If you
scroll down to the section 2008 - Monday's Gains - The Bad News: Weak
Volume in the October 13, 2008 article Bear
Markets Tend To Retest Lows, you can see volume
on SPY (S&P 500 ETF) at 2000-2002 bear market lows. Compare the chart of
SPY (2000-2002) to the chart of SPY above focusing on trading volume.
Strong
volume could still come, but it did not occur yesterday in a manner that is
similar to lasting market turns. In the up/down volume figures above (see red
box), we would like to see something in the 90% / 10% range rather than the
79% / 20% that we saw yesterday. Detailed research conducted by Lowery's
Reports over the last 76 years of market history supports the 90% / 10%
comment above. At a bear market bottom, we need to see powerful demand
for stocks.
Gold Had
A Bad Day: One day does not make a trend. Tuesday's pullback does
nothing to damage the uptrend off the October 2008 low. Volume on GLD and GDX
are somewhat high which is a little bit of a concern, but it is not
surprising to see a sharp retracement after a good run. Investors should
manage gold as we would any other investment, which includes monitoring gains
and losses and protecting capital when needed.
AIG Back
To Uncle Sam's Well - From Reuters:
NEW YORK -
American International Group, rescued twice last year by the U.S. government, is asking for more aid and bracing for a fourth-quarter loss of roughly
$60 billion, a source familiar with the matter said. It would be the biggest
loss in a quarter in corporate history.
FDIC Sees
More Trouble Ahead: Monday's Wall Street Journal reported FDIC
officials are "pushing Congress to raise the amount of money the agency
can borrow from Treasury to $100 billion, more than triple its current
limit". If the FDIC thought we were on the cusp of an economic and
housing turn, they would not be lobbying so hard for new funds. The FDIC
knows banks have much more pain in their future.
Housing
Prices and Banks Will Continue To Be Under Pressure: Stock
futures are higher in Monday's premarket on more government bailout news -
once again related to Citigroup. This bailout, as with many before it, does
not directly address the fundamental problem with housing - too much
inventory. As we have mentioned on numerous occasions, no government bailout
or mortgage program can alter the natural laws of supply and demand. Using
the pace of sales in December 2008, it would take 12.9 months to sell all the
new homes currently in inventory. We need to get down to five or six months
of inventory before we can expect to see prices stabilize. A glut of supply
means home prices will remain under pressure. Falling home prices means more
problems for banks. Mark Zandi, chief economist at Moody's Economy.com,
estimates that even with the new Obama foreclosure reduction plan, the United States will see 3.1 million foreclosures in 2009. We had a record 2.7 million in
2008. Home prices will continue to be a problem. Foreclosures will continue
to be a problem. Banks will continue to be a problem. Despite this morning's
hope of another lifeline for comatose Citigroup, the fundamental problems
with our economy remain.
Citigroup
- Third Bailout A Charm? The Wall Street Journal reported on Sunday
night the U.S. government is in talks with Citigroup to
"substantially" expand its ownership of the poorly managed bank. The
new deal could result in taxpayers owning up to 40% of Citigroup. With new
government bailouts coming at dizzying rates, it is easy to lose track of how
much the Feds have already committed to Citigroup. To refresh your
memory:
- October 2008: The Treasury
Department gave $25 billion to Citigroup
- November 2008: $20 billion
more was given to Citigroup
- November 2008: The government
agreed to protect Citigroup from losses on $301 billion in assets.
The sum
of the government's backing of Citigroup to date comes to roughly $346
billion. Has it worked? Below is a chart of Citigroup stock since October 1,
2008. The
market has not been impressed.
More
details on nationalization can be found in this Bloomberg article, Obama Bank Nationalization Is Focus of Speculation.
Ciovacco Capital
Chris
Ciovacco is the Chief Investment Officer for Ciovacco Capital Management,
LLC. More on the web at www.ciovaccocapital.com
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