HOVZ Stock Market Forecasts

September 21, 2008
OMG! What next???

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

What an amazing week it was for world financial markets! Early in the week a cataclysmic run on money market funds began without much fanfare. Quickly the financial community realized that the run jeopardized roughly $3.5 trillion in capital markets. No market threat of that scale and immediacy had ever developed before in the history of the World! Any previous financial panic could only look quaint and minor in comparison.

Then suddenly and with timing suitable for a Hollywood movie, a huge and only partly defined rescue was anounced by the Federal government. Full text. Over two days before the announcement world stock markets suffered a huge plunge. Then after the announcement there was an historic near-equal rebound. It was earth-shaking.

Hopefully the massive and unprecedented banking action has stopped the developing panic in its tracks. But the real short-term and long-term impacts are not at all clear. It is not even clear who the winners and losers are. Capital markets will probably loosen -- great news for the 'real economy'. But what happens to millions of consumers already over their heads in debt? What happens to lending institutions that are technically insolvent because of all their bad debt. The Treasury plan announced on Friday had very few specifics, so everything depends on the yet-to-be-determined details.

My guess -- just a wild guess -- is that stock market relief euphoria will fade quickly, and worry should return. Hopefully, it will just be anxiety rather than the paralyzing panic that has prevailed.

From here to Election Day uncertainty will still dominate stock markets.

1) After the U.S. election approximately half of the country will be deeply worried about what comes next. Right now, though, the entiire country is worried that the other team -- the bad guys -- will win. Most of the international investing community is troubled by the prospect of more years of a Bush-like administration.

2) September has a solid statistical record of being the worst month of the investing year. At this stage it doesn't matter whether the rationale for that is bogus -- regardless, there are plenty of people, including us, who are gun shy about September -- and it is only half-over! Historically, October isn't that great either.

3) The economic slowdown in the U.S. has not bottomed out yet and clearly is spreading overseas. The bailout may have forestalled a panic and possible depression -- but there is no clear evidence yet that it will avoid a deep and long lasting recession.

4) The Federal government has now assured that the credit markets will not freeze. But it is still unclear who exactly is getting bailed out. Is Treasury just making a market for troubled securities? Or is it letting lenders completely off the hook for their bad decisions. As I see it, further insolvency in the financial system is practically certain.

Three years from now today's damaged market prices are almost certain to appear to have been bargains. For right now, our guess is the relief rally will be brief. Things will probably get worse before they get better.

Bottom line:  Massive Federal intervention brought the developing panic to a screeching halt, but most of the underlying economic problems still remain. We are dubious about the strength of the new market rally. We'll let the dust settle. In a couple of months the situation may appear much different.

(This column is not investment advice, YOU need to figure out what's best for you.)

A Few Stock Market Indicators

Morningstar.Com Market Valuation graph  (Shows market to be 13% undervalued -- after diving down to -20% mid-week, very near the 2002 all-time-worst of 22% undervalued. There may be a huge stock market bubble somewhere -- but it isn't in the bulk of U.S. stocks that Morningstar tracks. We read this graph as saying that stocks are at 'sale' prices. On the other hand, there is just a one day track record of this chart trending up. ) This graph is a fundamental financial analysis / accounting calculation based on long-term projected returns for the 1,800 stocks Morningstar tracks.  Typically in the past couple of years the trend has gone from undervalued to somewhat overvalued. Click on the 'Maximum' tab for the best view of the Morningstar chart.

% Stocks Trading Above 200-Day Moving Average (The current value is shown at the very bottom of the link page. ) About 31% of stocks are above their 200-day average up from 18% a couple of months ago . In March it hit 17%, a typical bottom. This indicator is in buying territory and a base gradually has been forming. As a general rule, when a stock's price is above its 200-day moving average, the stock is in a long-term price rise. So, an increasing percentage of stocks priced above their 200-day moving average is generally a good sign. However, when 80% to 90% of stocks are trading above their averages it is usually a signal that euphoria has gotten out of hand and a market correction is due. Similarly, when only 20% to 30% of stocks are trading above average (like now), a sharp bullish upswing becomes very likely. For someone with a long term perspective, the market is in buying territory.

NYSE New Highs & New Lows If 'blood in the streets' is a good sign, then it is time for buying. The graph of new lows tracks fairly closely with our HOVZ Market Enthusiasm Indicator.  A 'Buy' indicator occurs when the number of Low values falls from a peak and a 'Sell' indicator occurs near when the number of new Highs peaks. www .InvestmentTools.com. 

Long Treasury Bond versus Discount Rate  High interest rates tend to be bad for corporate profits and stock market prices. For banks the nightmare scenario is when the short term rate they borrow money at climbs higher than the long term rate at which they lend money out. So it is little wonder that the banking world disintegrated in the past 2 years as the Fed cranked rates higher.

Now, the Fed has dramatically lowered short term lending rates creating a major stimulus to keep the economy pumped up. The difference between the short and long rates is seldom greater than it is now. Few economists are expecting another rate cut in the near future.(MarketWatch.com forecast, bottom of linked page). Unfortunately, the flip side of this is that low rates like this are a direct statement that the Fed is really worried about the economy. It takes time for the stimulus of low rates to start working through the real economy and there is a major concern that moving rates too low could cause the value of the U.S. dollar to go into free fall. (Hey HOVZ, what do you mean, "could cause?" -- The dollar already has been in an extended slide for years. Recent dollar strength is unlikely to last.) The rate inversion that existed during most of last year ended up being a good predictor of the extended market troubles we are feeling now.

Short Interest Ratio (from InvestmentTools.com) This is really strange -- the ratio never seems to have dropped this far this fast before. We thought it was bad data, but apparently the data is correct. This number derived from NYSE data is the dollar value of total outstanding short positions divided by the value of an average day of trading -- essentially, how many days would it take to close all short positions. Watch the moving average of this indicator for a very broad look at the anxiety level of the stock market.

Margin Debt  In a surprise to us, margin debt has recovered from being below its 20 period moving average. Good news, even though margin levels still are well below where they were last year. People who borrow money to buy stock (i.e. "buying on margin") fall into two groups. First, they might be optimists, convinced that the market is going up. On the other hand they can be hedgers, confident that they can borrow money to go long on 'winners' and short 'losers.' A rising level of margin is a good sign of a confident Bull market.  A persistently falling margin level is a clear sign of a Bear market -- the optimists get frightened and the hedgers flee the scene.

This chart from www.InvestmentTools.com shows that for the past few years we have been is a very strong period of rising margin, possibly too strong. The total amount of margin borrowing has surpassed the historic high reached in 2000. Here is the NYSE data link.

Building Permits and Housing Starts (Major negative factor seldom worse than it is right now. It takes an optimist to take heart that things seldom appear to have been worse than now.). Housing related activity -- not just construction, but including all factors such as new appliances -- constitutes roughly 20% to 25% of the U.S. economy, so it is much too big to ignore. These linked charts from the St. Louis Federal Reserve provide a way to watch the slow moving collapse unfold. Housing tends to lead the stock market by approximately one year. If so, that is very bad news. Here is a Wikipedia background piece on the U.S. Housing Bubble

U.S. Leading Economic Indicator   Rose in August -- but one month doesn't make a pattern. (See graph at bottom of link page.) The eLEI did well in April and May, but jumped off a cliff in June! A competing and better known indicator, the Conference Board Leading Economic Indicator reports a decline in August.

Anxious Index (xls file) (Negative. It was just a headfake when it seemed to be improving. This indicator is about as bad as it gets.) This article by David Leonhardt in the NY Times a couple of months ago said the Index pointed toward an economic recession. He noted this Survey of Professional Forecasters maintained by the Philadelphia Federal Reserve hasn't missed calling a recession or called a false positive in the years since 1968 when it was started. Updated quarterly.

U.S. Federal Deficit (from St. Louis Federal Reserve) Be careful what you wish for! Before last week's emergency Government intervention the deficit was headed toward $500 billion/year. But now with the Treasury seeking authority to buy up to $700 billion in bad mortgages? Who knows! The U.S. Dollar has been falling for years. It has looked better recently, but as long at the U.S. balance of payments is so terrible, and the spending faucet has been turned on full, we just can't believe that the Dollar will jump up too high. Bloomberg appears to agree.

Effective Federal Funds Rate and Target Interest Rate (from St. Louis Federal Reserve) Negative in the short-term, but soon because of lag times it will become a positive factor. The Fed has rushed like it never has before to drop short-term rates. At 2% there is not much further they can go. The quarter point reduction on 4/30 was a sign that rate cuts are near an end. Recent statements from Chairman Bernanke and other Fed members all point to a freeze on rates for now. Eventually rate cuts will stimulate the economy. But, because of lag times, for now it is a major contrary signal showing just how worried they are at the Fed. The current MarketWatch.com forecast of interest rates points toward no rate changes for while at least.)

Price / Earnings Ratio of the SP-500  (Rising P/E because of falling profits is bad news.) The P/E ratio has spiked up in recent months, a sign of earnings going down sharply, especially in the previously profitable financial sector. This is a sign of bad economic news.

Halloween Indicator: Negative The old saying "Sell in May and go away" and buy back after Halloween turns out to have statistical validity. We will add some links here in coming weeks. The addage was certainly right this year! Anyway, this one says to stay out of stocks until November 1. Hmmm... right near the presidential election. Hmmm...