By Doug Kass | 16 March 2009
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Nearly two weeks ago, I suggested that a 2009 market bottom had been put in, and last week I surmised that, in the fullness of time, a generational market low might have been put in for the U.S. stock market. At inflection points, gauging the market's technical bearings is often useful as a history lesson, so let's travel that route.
A deeply oversold, worsening sentiment and positive internal divergences almost always provide the foundation for stock market recovery. The move from the October lows to the March lows indicated growing fear and gave way to rising cash positions and the loss of hope, but the market's internals were improving. November's DJIA low of 7,552 was nearly 11% below the October low of 8,451 and the March low of 6,547 was 22.5% under October's low. Each new low was more frightening than the prior one.
However, there were improving technical and sentiment signals— for example NYSE volume at the October low expanded to 2.85 billion shares; at the November low, volume dropped to 2.23 billion shares; and at the March low, volume was only 1.56 billion shares. As well, new lows traced decreasing levels: At the October low, there were 2,900 new lows; at the November low, there were 1,515 lows; and at the March low, there were only 855 new lows on the NYSE.
Moreover, from a sentiment standpoint, the March low marked an unprecedented number of bears, according to the AAII Survey. (I have recently addressed one of the only debatable sentiment indicators— namely, a stubbornly low put/call ratio— as increasingly inconsequential, owing to record low net long positions for hedge funds and more limited individual investor exposure, which negates the need for put protection.)
Last week (and right on cue!), we witnessed conspicuous breakouts and strengthening momentum off Monday's bottom. The combination of Tuesday's 12:1 ratio of advancing stocks over declining stocks coupled with that day's 27:1 up-to-down volume ratio has not occurred in almost 65 years. The 9% three-day rally and rising volume on two 90% up days was very encouraging.
I was also inspired by the improving conditions of my watch list, particularly the strength of financial stocks and the ability of many stocks (e.g. General Electric (GE)) to advance in the face of bad news. (In the case of GE, that was a Fitch downgrade late in the week.) Most strong rallies don't let investors back in easily and get overbought quickly. I expect the current one to be sharp initially and to continue without much of a retest over the next week, creating a short-term overbought by month's end.
So, how now, Dow Jones?
"History doesn't repeat itself; at best, it sometimes rhymes."
— Mark Twain
As a template, I expect the 2008-2009 stock market price pattern to most resemble the 1937-1939 period. The technical parallel mirrors a similar fundamental backdrop. Let's first examine the 1937-1939 charts versus today.
Dow In The '30s & '40s Vs. Nasdaq Now— Very Similar Patterns
Click Here, or on the image, to see a larger, undistorted image.
source: Reuters
1. The stock market decline followed a four— to five-year rally, after a three-year decline of greater than 80%, which is similar to the Nasdaq experience.
2. Worldwide industrial production collapsed in 1937.
3. Commodities crashed in 1937.
4. The markets spent five years consolidating the declines.
5. Massive government spending pulled the U.S. out of The Great Depression. (Back then, it was preparation for WWII; this time, it will be government stimulus/infrastructure.)
The 50% drop over a five month period in 1937-1938 is similar to the market's recent drop in that neither had a high-volume selling climax. The market's 1938-1939 recovery, perhaps like 2009's, had four legs and lasted about seven months. Leg one of the 1938-1939 rally was brief and intense; it lasted only about 12 trading days, and the indices rose by 19%.
Leg two was an approximate 60-day consolidation that corrected half of the initial gain. Leg three was about a six-week rise of 30%. Leg four consisted of another two-month consolidation and retracement followed by a 22% six-week rally, serving to mark a multiyear high in the averages.
I expect a similar pattern (as in the late 1930s) to be traced ahead in 2009. An audacious forecast: In the months ahead, the fear of being in will be replaced by the fear of being out. Here is a chart of my expectation for the SPDRs in the months ahead.
SPDR Trust (SPY)— Expectations
Click Here, or on the image, to see a larger, undistorted image.
A poorly positioned hedge fund community, with an historically low net long exposure and rankled by negative investment returns and the fear of continued redemptions, should provide the initial thrust to the S&P's 50-day moving average of about 810. It is important to recognize that, historically, strong rallies that have durability (as in 1937-1938), as previously written, typically don't let investors in during the first advancing leg. With such a clear burst of momentum, the fear of being out could drive the S&P 500 as much as 15 to 40 points above the 50-day moving average, paralleling the 20% third-quarter 1938 move and producing a short-term top and a temporarily overbought market.
The spring should be characterized by a backing and filling as the sharp gains are digested, similar to the the September-October 1938 interval. Sloppy second-quarter warnings will weigh on the market during the April-May period, but the markets could move sideways, bending but not breaking. Signs of market skepticism, sequential economic growth and evidence of a bottoming in the residential real estate and automobile markets (after a sustained period of under-production) could contain the market's downside, providing a range-bound market with a firm bid on dips.
As well, the results from the bank 'stress tests' and the release of a more coherent and detailed bank 'rescue package' could provide further support to equities. By June, economic traction should begin to take hold from the accumulated fiscal and monetary stimulation coupled with the large drop in energy prices. While it will be too early to demonstrate a broad economic recovery, evidence of stabilization will be clearly manifested in improving retail sales, and stocks will take off for their final advancing phase.
Fixed income will come under increasing pressure. Large asset allocation programs at some of the largest and late-to-the party pension plans (out of bonds and into stocks) could trigger an explosive rally in the middle to late summer. This move by July or August could close the October 2008 gap in the SPDRs at around $107.
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Normxxx
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