Newsletters 2009 Newsletters The Worst has Passed (4/09)
Friday, 10 April 2009 19:05
The stock market rebounded sharply from what appears to be (at the very least) a significant bottom. Indeed, the March 9th market low may even prove to be the low for this awful economic cycle that began in December 2007. The S&P 500 Composite, Dow Jones Industrial Average and NASDAQ Composite gained 8.54%, 7.73% and 10.94% respectively for the month of March. While these major market indices remain down by –11.67%, -13.50% and –3.07% respectively for the first quarter of calendar 2009, they all have risen north of 20% from the March 9th low.
To be sure, a significant portion of the current “bear market rally” is directly related to the surge in short sellers buying into the market, forced to cover their bearish bets. With short interest having reached an amazing peak of approximately $1 trillion, we have long suggested that this would add substantial fuel to the ultimate market recovery. However, a short-covering rally provides us nothing substantive to hang our hat on, so the current rally will require technical and economic “proof” to be deemed sustainable. And only time will tell if the March low proves to be the low.
On the technical front, we are encouraged that the March lows were not accompanied by an ever-rising number of new stocks hitting fresh lows. In fact, the number of new companies reaching a 52-week low peaked in October of 2008 and has steadily diminished since then. This steadily lower volume of new lows has occurred despite the wave of mass fear and seemingly washed-out pessimism that coincided with the early March low. The pervasive gloom of early March sparked a sense of hopelessness and an avalanche of mutual fund outflows that is consistent with major market bottoms.
Further, the subsequent March rebound has witnessed strong technical underpinnings that suggest a broad advance in the markets, whereas previous attempts to rally were led by those sectors such as financials that were the most heavily shorted. During the March rebound, the ratio of advancing stocks over declining stocks and up-to-down volume has given clear signs of a broadening of market participation in the rally. Infamous bear-turned-bull Doug Kass reports that the March 24th “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”.
Even more important than the encouraging technical dynamics, the recent rally has been accompanied by better-than-expected economic developments. Consider the following:
- U.S. durable goods orders jumped 3.4% in February, much better than the expectation for a 2% drop
- The Philadelphia Fed’s Business Outlook Survey improved to –35 in March from –41.3 in February.
- Existing home sales in the U.S. rebounded 5.1% in February, as the supply of homes held steady at 9.7 months and the median price fell to $165,400.
- Pending home sales in the U.S. rebounded 2.1% in February.
- The Federal Housing Finance Agency reported that the price of houses financed solely by conventional (non-jumbo) mortgage loans rose by 1.7% in January, the first such increase in a year.
- Personal consumption rose by .2% in February, following a similar increase in January.
- The Conference Board consumer confidence index edged up to 26 in March from 25.3 in February.
- The University of Michigan consumer sentiment index improved to 57.3 in March from 56.3 in February.
- Mortgage rates fell to a record low 4.48% for 30-year conventional loans as mortgage applications rose 3% during the final week of March.
- The ISM manufacturing index rose to 36.3 in March from 35.8 in February.
- The Challenger, Gray index of planned job cuts fell in March after also falling in February.
What is perhaps the most impressive element to the above economic data and perhaps even more telling of the potential sustainability of the current market rebound is the fact that these economic improvements occurred even before several government initiatives, initiatives that may prove to be game-changing singularly and even massively stimulative taken collectively. We can’t help but prognosticate that a floor has been established since the economy has stabilized even before the following initiatives have taken hold:
- The Fed announced in mid-March its intention to accelerate its quantitative easing campaign by expanding its purchase of mortgage-backed securities by $700 billion and also stepping in to acquire $300 billion of U.S. Treasuries. Yields on safe fixed securities and mortgages plummeted on the news.
- The so-called TALF or $1 trillion Term Asset Lending Facility is designed to loosen credit conditions for consumer related financing such as car loans and student loans and is finally functioning.
- The U.S. Congress passed $787 billion stimulus bill went into effect April 1, 2009.
- Treasury Secretary Timothy Geithner unveiled a “Public-Private Investment Program” to facilitate the private sector buying toxic mortgage assets from banks with financing and government guarantees that is expected to remove $1 trillion of bad loans from bank balance sheets.
- Revisions to mark-to market accounting were finally approved in the first days of April.
The SEC is set to bring back the uptick rule and potentially other circuit breaker considerations that limit volatility.The above programs amount to approximately $4 trillion of potential stimulus. On their own, the recent string of better-than-expected economic data illustrate that the U.S. economy is not going into a deeper black hole. On their own, the economic news supports our thesis that this is not the second coming of the Great Depression. Over time, we are confident that the massive stimulus now in place will have its desired positive impact on the economy and will be sufficient to thwart the deflationary impulses we currently face. The pessimists have underestimated the recovery already under way, rooted in the Fed’s bold actions undertaken over the previous two quarters. With the impact of another $4 trillion now in the pipeline, we are increasingly confident that the worst is behind us and that “buying on the dip” is likely to replace “selling into strength” as the new market mantra.
To be clear, we expect additional volatility and continued “backing and filling” as the market climbs a very healthy “wall of worry”. While we do not think that the market is ready to zoom higher, we do believe that the “end of Depression” trade at least takes the notion of lower lows off the table. The sharp move off the March 9 lows supported by strong technical evidence and better-than-expected economic news, with $4 trillion of yet-to-be felt stimulus providing an additional backstop, should be enough to entice at least some of the $4 trillion (that’s a different $4 trillion) of sidelined cash back into the market.
At the risk of being early, we can’t help but think that the massive stimulus now in place will eventually lead to an environment where inflation, not deflation, is the prevailing economic boogeyman. When that day arrives, investors that have flocked to the “safety” of Treasury bonds will find it increasingly difficult to wait until maturity to offset growing losses in principal. When that day arrives, we would not be surprised to see the dollar lose its steam and anticipate that our foreign investments and global blue-chips that earn a majority of earnings overseas will serve us well. Historically, the best hedge against inflation is the earnings and dividend growth offered by quality equity investments. We are well positioned to not only ride through the current economic storm but also to thrive once the reflationary trend takes hold.
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