By Mike Swanson | 1 March 2009
In the Fall when the stock market crashed I think it was obvious that the United States— and the rest of the world— was in a financial crisis, that would lead to a severe recession. However, after the crash by December it also seemed logical to expect some sort of counter trend rally. Even though we were in a bear market I did not think it would be a good time to short until sometime in 2009. Therefore the only way to try to make money would be to go long.
So I tried to do that, by going long the only sector in the market that looked to me to have the ability to begin a new bull market in the first quarter of 2009— airlines. As the market fell in January though I got stopped out for a small loss. Of course this is the type of thing that happens when you try to go against the big trend of the market— you lose money.
That trade reminded me once again of the importance of recognizing the reality of the bear market. That means the best way to make money this year will be to try to short the market when it has its 10-20% rallies until it is clear that the bear market is over. The thing is though very few people are respecting the big trend. Almost every single email I've gotten since this year began has been from someone wanting to go long the market— they either want to know what stocks to buy or are enamored with gold or energy stocks.
I get the impression that many of these emails are coming from people who are total beginners in the stock market— which I tend to get a lot of, because I really try to educate people with my writings and website. However, all of these people seem to think all they need to do is buy into the right thing on the next rally.
But this isn't like the old days, pre-2000, when you could just buy a stock and see it go up. In a bear market stock picking means absolutely nothing. The only thing that matters is respecting the broad trend of the market. Trying to pick the right stocks is a fool's game until this bear market is over.
Most people don't know that— especially people just starting in the stock market, because every book they read and all the talking heads on TV want to teach them or tell them to buy stocks. People are watching Cramer and Fast Money and think the stock market is just going to print them money— it's just a matter of waiting a few more months for the next bull to come along.
In bear markets though you get your occasional 10-20% rally, but trying to pick stocks and go long isn't a winning strategy. Even playing the rallies doesn't benefit you much. The best way to make money is to short rallies and have heavy cash reserves available so you'll be able to buy in when it is clear that the bear market is over.
The only thing that has a chance to go up this year is gold stocks and I'm not sure about them. [[and, indeed they won't, seriously, so long as we are in deflation.: normxxx]] And that leads to my last change of heart. Although I tried to dabble on the long side at the beginning of the year, by the end of January it became clear to me that this recession and bear market is going to be much worse than most people imagine.
The 4th quarter GDP numbers released a few weeks ago were a real eye opener to me and created the last turning point in my thinking. The [[preliminary estimate of : normxxx]] -3.8% [[since adjusted to -6.2%: normxxx]] was better than expectations, because it was helped by a steep drop in consumer prices to the tune of 17.8% for durable goods. Yes, the price for big ticket items fell 17.8% from where they were a year ago. That is deflation folks— nightmare deflation— and helped the GDP report "beat" its number.
Oh yeah government spending— which rose 5.8%— helped too. So did a big rise in inventories. Both the fall in prices and rise in inventories helped the overall number, but in reality they are very troubling signs. Inventories rose because people couldn't sell their stuff.
Inside the report, overall nominal demand was shown to have collapsed at an 8.9% annualized rate. Consumer spending fell 3%. Consumption as a percentage of GDP shrank from 71% in the third quarter to 63% in the fourth quarter.
Now if this was the end of the recession none of this would matter. We would go run out and buy stocks right now. But business investment— which is more of a forward leading indicator— fell 19.1%. That's the worst performance since the early 1980's. You can't expect economic growth in an economy when business investment is in freefall.
To me it looks like the economic recession is picking up steam and if we are going to get a trough in the recession next year, then you have to ask yourself how much worse is it going to get? It is unreasonable to expect a bull market to begin anytime soon in such an environment. In fact this could easily lead to the type of bear market bottoms that we saw in 1982, 1933, and after WWI and WWII.
I don't know exactly how it would get there— but that would mean the S&P 500 falling below 600 and probably to 500 by the end of this year or sometime in the first half of next year. Maybe we will still rally here first. That is what I was expecting— a big rally into March-June then a big drop.
I looked at the historical data— and the only times that the economy contracted that much in a single quarter were associated with these major bottoms. Now they didn't mark the bottom— what they did was show you an economic environment so brutal that stocks fell until they actually became absurdly cheap. So cheap, that the stock value of operating companies were actually cheaper than their break up values— well below their book values.
For our market to get this cheap, the S&P 500 would have to fall into the 500-600 area, and even below 500 is possible. The other thing all of these environments had in common was deflation in consumer and producer prices. This is something that is happening right now.
The problem is the economy. The recession is not going to end this year, because real estate prices are not going to bottom out this year. According to futures contracts on the Schiller/Case real estate index there will be no bottom in real estate until at least the second half of 2010— they are projecting a bottom sometime in the fourth quarter of 2010 and first quarter of 2011.
That is over a year and a half from now from now.
What I've come to conclude over the past few weeks is that we are not in a 'normal', Fed induced recession and that most people do not recognize this. They think this is maybe like the 1970's, in which the market went sideways because there was a lot of inflation (but inflation adjusted, the Dow lost over 70%). Gold and commodities went up and so did some stocks during that time.
People think the Fed has gone crazy printing money and any rally could be the start of the next bull market and runaway inflation (if not hyper-inflation) simply because of that fact. Therefore they are desperately looking for new stocks to buy into on the first likely rally, or are just holding on to their losing positions long enough for them to go up again. No one is really preparing for the bear market to continue.
But I think this bear market is going to to be longer in duration and more severe than almost everyone expects (and could easily give 1929-1933 a run for the records). If I'm right, stocks will become so cheap that those that buy in when this bear market ends, probably sometime next year, will make a fortune. And those that learn how to trade market trends and short bear market rallies will make a ton of money this year before then.
This is a bit different than what I was thinking at the start of the year. I never experienced the 1930's bear market or lived in Japan in the 1990's. My experience is the same experience as most Americans of today when it comes to the stock market— the past thirty years. I saw the last bear market and the last bull market. I was thinking we could see some base building and a recovery like we saw from the second half of 2002 through 2003 after the last bear market, because the stock market dropped by half last year.
Just about everyone I know was thinking at the start of this year that the market had fallen so much last Fall, that it just HAD to be the bottom or at least the start of a really big rally. That, and the fact that it didn't seem to be a good time to short, seasonally speaking, so I was only looking for long opportunities. And that led me to dabble for a few weeks on the long side and bet against the primary trend of the market. I quickly recognized the error of that way of thinking.
The reality of the economic data has made me conclude that this was just a momentary bout of overly optimistic thinking on my part. I think the market is going to go lower over the course of the this year and I'm ready for that. I'm ready to go short against the market the next time it has a 10-20% rally. I'm ready to make money in this market. I hear what the market is saying and I'm listening. Are you?
‘Dow Theory’ Says Worst Isn’t Over For U.S. Stocks
By Eric Martin and Cristina Alesci, Bloomberg | 21 February 2009
Feb. 21 (Bloomberg)— A 125-year-old method for forecasting the market is telling investors the worst isn’t over for stocks. Dow Theory, which holds that simultaneous moves in industrial and transportation shares foreshadow economic activity, indicates the Dow Jones Industrial Average’s drop to a six-year low yesterday may presage still more losses. The Dow industrials slumped to 7,365.67 on concern the deepening recession will force the U.S. government to bail out banks. Adherents of Dow Theory say the 30-stock gauge will fall farther because the Dow Jones Transportation Average has slipped to the worst level since September 2003.
"When you have that confirmation in both legs, that’s clearly negative," said Ryan Detrick, senior technical analyst at Schaeffer’s Investment Research in Cincinnati. "There’s some validity to Dow Theory." This week’s retreat left the Standard & Poor’s 500 Index, the benchmark for U.S. stocks, within 2.3 percent of breaking through its Nov. 20 low to the worst level since 1997.
Citigroup Inc. and Bank of America Corp. declined the most in the Dow this week, losing more than 31 percent, on concern shareholders will be wiped out through nationalization. General Motors Corp. had the third-biggest slump, losing 29 percent on concern about its solvency. General Electric Co. dropped 18 percent to $9.38, becoming the fifth stock in the average since last year to sink below $10.
"The direction of the market is clearly down," said Richard Moroney, who manages $150 million at Hammond, Indiana— based Horizon Investment Services and edits the Dow Theory Forecasts newsletter. "We’re holding a lot more cash than we normally do."
Dow Theory, created by Wall Street Journal co-founder Charles Dow in 1884, argues that transportation companies are harbingers of economic activity. The transportation gauge slipped below its November nadir in January and has kept retreating. YRC Worldwide Inc. and JetBlue Airways Corp. fell the most this week, losing more than 27 percent.
Dow Theory is showing that "the bear market is in full force," said Philip Roth, the New York-based chief technical analyst at Miller Tabak & Co. "It doesn’t tell you whether it’s going to last another year or another day. It isn’t a forecaster of magnitude, just direction." In November 2007, one month after the Dow industrials and S&P 500 surged to record highs, Dow Theory suggested the rally was over. The S&P 500 went on to tumble 38 percent in 2008, the most since 1937.
The Dow Theory signal goes against all 10 Wall Street strategists tracked by Bloomberg, who on average project the S&P 500 will end the year at 1,059, a 38 percent gain from Thursday’s close of 770.05. Almost $800 billion in federal spending and the cheapest valuations in two decades will spur the rally, the strategists say.
The S&P 500 is a better indicator of the market’s direction because it has almost 17 times more companies than the Dow average and uses market value, not share prices, to determine company weightings, said Roger Volz, New York-based senior vice president at Hampton Securities Ltd. and a technical analyst since 1982. The index would probably plunge to 681 should it fall below the 11-year-low of 752.44 reached in November, according to Volz. His chart-based techniques include Fibonacci analysis.
"I don’t think we get out of the woods for 14 months," he said. "The destruction is severe."
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