HOVZ Stock Market Forecasts

September 28, 2008
Scary movie continues...

All HOVZ Archived Commentary
Links to Other Stock Market Indicators .

Last week I wrote: Hopefully the massive and unprecedented Federal financial initiative proposed this week stopped the developing panic in its tracks.

Well, not so fast. With stock markets down another two percent, chaos still reigns at this writing. The huge push to give birth to some kind of program -- ANY kind of program -- this weekend shows panic. But why the rush? These problems have been known for years or at least months. There must be some very scary 3rd quarter financial reports lurking in the wings!

Then, if some sort of rescue does get passed by Congress, most observers now seem to feel that the actual impact is totally uncertain. And finally, IF the bailout plan does avert world-wide financial collapse, then the best outcome that can be hoped for is several years of hard times.

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. The Economist is running a US election poll of its readers and is posting the results as if world voting was allotted like the Electoral College. The results posted here are now showing Barak Obama 7,999 and John McCain 12.

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's not 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 any relief rally will be brief. Things will probably get worse before they get better.

Bottom line:  Promisef 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 any 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 17% undervalued -- still fairly 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. Or, at least THEY don't think so. We read this graph as saying that stocks are at 'sale' prices. On the other hand, there is no sign this chart is 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 23% of stocks are above their 200-day average. 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. For someone with a short term perspective it sure looks like the sky is falling.

NYSE New Highs & New Lows If 'blood in the streets' is a good sign, then it is time for buying. There have not been this many new lows for at least 6 years! Of course, next week there might be plenty more. 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.

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. The odds of a bit more rate cutting have now crept up. (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 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. Since the market has already fallen off a cliff, many speculators have closed their short positions, pocketed their winnings, and are waiting for the next round to begin.

Margin Debt  Dropped significantly in August giving another sign of market fear. Margin levels still are well below where they were last year, and the rate of change is down at recession levels. 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. 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 hints that rates are more likely to drop a bit more rather than rise.)

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. The way a graph is drawn makes a huge difference in the story it tells. First take a look at the graph linked at the start of this paragraph, then look at this longer term graph of the P/E of the SP-500 presented in the NY Times by David Leonhardt. Regardless of the view, I don't see all that much value in this as a short-term market indicator.

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...