Monday, August 03, 2009

What's Up With the Market?

I probably get about three or four emails or girly chats a week from people asking me what I think about the stock market these days. Everywhere I go there is somebody who has talked the market with me before, and I'm constantly getting asked for my thoughts. Last year as things crumbled to the ground, of course, this was an extremely hot topic, and frankly I made most of my thoughts known here as far as wanting to buy in when stocks got as low as they did. Well, now as the market has just rallied stronger than anybody could have ever believed over the past few months -- up around 45% from the March lows on the S&P 500 -- the interest level seems to be rising once again, as more and more people become dismayed with the degree of this latest surge after last year's tumultuous tumble.

The most common thing I hear, to be perfectly honest, is "When do you think the rally will crumble?" In fact, probably at least half of the people I talk to regularly about the stock market seem to believe that this latest rally is way overdone, and that people are just being silly to be pushing up stock prices this much, this fast, they're creating another bubble, yadda yadda yadda. The general consensus seems to be that those who are buying into this particular rally are surely destined to get their comeuppance soon enough in the form of a vicious bear market to eradicate most or all of their gains all based on bubble valuations and blind-eye gains.

Well, I'm here to tell you that I don't agree. At least not yet. There are a lot of reasons why.

First and foremost, Dow 9,200 is not ridiculously high. It's just not. Although ultimately one can always classify this statement as just an opinion, it's really not something that people who truly understand the market and historical valuations would ever disagree with. I don't care how low the market went late last year, again in January, and finally again in March earlier this year, but with where stock prices had been trading as recently as a couple, few years ago, when I look at Dow 9,200 -- and especially when I look at the individual stock prices that go into creating a level of 9200 for the 30 DJIA stocks -- I don't see a bunch of overinflated, fluffy stocks with plenty of room to sell them down hard. At Dow 14,000 two years ago, maybe. But at Dow 9,200, stocks are still probably closer to looking cheap than to looking expensive.

Now don't take that last statement too far -- I don't really mean to be saying that I'm some kind of huge bull on the short-term of the U.S. stock markets here at Dow 9,200. But I'm definitely not in the camp of those who scoff every day when the market is up again these days -- and I know there are literally millions of you out there -- thinking how speculatively-valued all the big stocks in the market are becoming again. To put it another way -- and anybody who knows me and chatted with me regularly over the past several months heard it from me live when it was happening -- but it was Dow 6,547 back on March 9, 2009 that I thought looked truly silly. I mean, that's the shit that was stupid, not Dow 9,200. And I'm someone who's followed the market like a hawk for almost 25 years at this point, since back when the Dow was in the 1000's, so there's more than a little perspective behind that statement. That's why I was right here, for example, on March 13, extolling the virtues of buying the Proshares 2x-leveraged Long Financials ETF which trades under the stock symbol UYG, which had touched $1.37 a share a couple of days earlier (as I type this, UYG is up around 330% since that price) -- because everywhere I looked back at Dow 6,500, all I saw were obvious buys. Absolute, raging, screaming buys. GE was at friggin $6.60 for crying out loud (Warren Buffet bought $5 billion of preferred stock earlier with the GE common trading at around $21 a share), Amazon was below $40, Apple was below $80, oil stocks were cheap, gold was cheap, everything was effing cheap as hell.

Despite where we were just five short months ago now, try as I might I just cannot see stock prices today as looking particularly expensive. With the Dow already having rallied back from 6,500 to 9,200, I therefore do not agree with the growing consensus that things have moved too far and we cannot go much higher. In fact, for many reasons I would guess at this point that it's a pretty good bet that we will rally a bit more from here. For starters, the economy clearly has bottomed. A couple of months ago at this point. Sure, the employment situation is still downright frightening right now in the U.S., but employment is always a lagging indicator, and all the other figures show that things fell off a cliff late in 2008, stayed that way in the first quarter of 2009, but in the second quarter -- which ended on June 30 -- the rate of decline in the national GDP slowed to just over 1%. And things don't seem any worse right now here in early August than they did over the past few months -- if anything, the beginning of Q2 (April) was probably still feeling some residual slowness after the March stock market lows, while Q3 is likely to begin at around the same pace as the improved growth from the final months of Q2 and stronger than the previous quarter started, so Q3 GDP can hopefully be another positive sign to look forward to.

Moreover, those jobs figures are likely to begin improving any month now, if you assume for example that the "bottom" for the economy was the same as with the stock market and just call it March of this year. That leaves April, May, June, July and now into August that employers have had to figure out that the economy is currently in bounceback mode and start adjusting up hiring or at least adjusting down the firing. That means that this week, when the July jobs number comes out, we will get our first look at how employers acted with now four full months of data on the economic rebound in order to plan their hiring strategies. If the July numbers are not better than expected -- and sadly I am talking about a month with under 300,000 jobs lost or so -- then the August and September numbers are very likely to be positive surprises. And the fact that we probably have another couple of months of positive reports in some significant economic figures coming right down the pike is only going to help bolster the whole recovery theme further. And keep in mind all that "stimulus" spending that Barack Obama and the Congress pushed through earlier this year, which represents hundreds of millions of dollars a year of "synthetic", mint-financed spending which will no doubt also have a measurable effect on the economy as a whole, both directly and indirectly, for a long time to come.

On top of the economic influence on the markets, psychology probably plays at least an equally important factor, and again I think the psychology of the market right now is such that we are still -- at the moment of writing this at least -- in rally mode. For starters, it has been a common technical indicator over time that in a bounceback from a sharp rally or a sharp selloff, it is common for a major index to retrace close to 50% of its overall previous change as it adjusts to the new changed level. For example, in this case the Dow fell from 14,100 in October 2007 to 6,600 in March 2009. An exact 50% retracement of that often dizzying 7,500-point drop would bring the Dow back up to 10,300. That leaves around another 12-13% to go still from current prices. Similarly, the S&P 500 closed at 676 and change on March 9 of this year, after having closed as high as 1,565 on October 9, 2007. A 50% retracement there would bring the S&P 500 back up to 1120, while the index currently sits only at 987. That leaves another 13% there as well to rise, if the markets are to follow the common practice of recovering half of the losses before the next leg staying in the bottom half of the recent trading range.

One other factor I just can't keep coming back to is Dow 10,000. I know it's only psychology, but I'm telling you, things like the Dow crossing back over the 10k mark have a very meaningful effect on a huge swath of investors' mindsets, both in this country, and among foreign investors in U.S. markets, where things like superstition, lucky numbers, etc. are at least as popular as they are in America. And in this case, I simply cannot envision Dow 10,000 again without an accompanying selloff in stock prices. I just can't picture it any other way in my mind, much as I would like to. I think we could easily rally up to or near 10,000 on the Dow -- which would be roughly consistent with that 50% retracement rule that often applies after big inflection points in the market's history -- and then experience quite a bit of pushback from individuals and institutions following the "won't get burned again" mentality once the Dow claws its way back up to five figures. But part of believing that a retest of the 10,000 will likely fail, at least at first, is believing that the Dow could find its way back up to that point to begin with. The psychology of the market is such that it may want to see a re-test, and may subtly make it happen by rallying things up to that point. It has often been a quick and easy push for the last several percent on the way to a significant re-test at a major high- or low-water mark in the major indices, something that's been happening in the stock market since time immemorial. I've seen it happen a thousand times before, and I'll see it a thousand times again. This is just how the market works sometimes, as any market pro knows.

Healthcare has been sufficiently whittled down from the ridiculous overspending that is becoming this president's main theme so far. The bank bailouts -- unpalatable on every level as they are -- appear to have worked, in that the mainstays of the industry have been kept afloat, crisis averted. The economy bottomed months ago, and all signs point to unemployment moderating in coming months as employers realize that the sky, indeed, is not falling as many had predicted. So far the long-term fallout from the financial meltdown has been, while quite significant, not the catastrophic event for all of America that many had feared just a few months ago. And Dow 9,200 is just not that expensive, not on any scale used by normal human beings. There is room to grow a bit more from here, and a 10-15% rally is never anything to sneeze at. I'm still looking to buy whenever a particular sector or stock I like gets cheap, having rotated into some oil stocks a couple of months ago when crude prices fell to $40 a barrel, and I will continue to do so at it seems appropriate given the current market action. But as we get above the 9,500 level or so on the Dow, I will be starting to look for some stocks that are approaching long-term technical tops on their charts, and/or shares in companies that appear to be running into growth problems or funding issues for whatever reason. Those are the places I will want to be buying some put options to hopefully profit from everyone else selling off when the Dow gets close to the key 10,000 mark.

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3 Comments:

Blogger spritpot said...

I think prices in the stock market are pretty fair right now. There are a couple of stocks I think are too high (looking at you, AMZN), but overall pretty reasonable.

I don't agree with you about Obama's health care plan being "ridiculous spending" though. From a societal point of view, the larger government's share of national health care spending, the better deal we get.

-bruechips

1:50 AM  
Blogger John said...

there are guys like huffington and http://www.forecastfortomorrow.com that keep bringing the truth....but obama and his clowns dont... and i underline the word clowns there....this whole thing is a charade and a joke peoples.

god bless and prepare for the coming 12 months...i am not joking.

9:49 PM  
Blogger Astin said...

Dip dip dip.

Maybe not March low (that dependso n panic), but this is too high. Any "recovery" that's going on is on the backs of taxpayers and in bubble creation. So much for ending the boom-bust cycle.

11:42 PM  

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