Expert Predictions: Finding Value in Knife's Edge Markets

The list of well-known names identifying value on the U.S. stock market at current levels is growing by the day and includes the likes of Jeremy Grantham (GMO – “Careful buying is justified”), Warren Buffett (“Buy America. I am”), John Hussman (Hussman Funds – “Why Warren Buffett is right” and “How low, how bad, how long?”) and Barry Ritholtz (The Big Picture – “Another buy in”). Even perma-bears such as James Montier and Albert Edwards (Société Générale – “Turning more bullish”) are increasing their equity exposure, albeit only for the short term.

Edwards sees the S&P 500 Index finally bottoming at 500, Grantham expects an “overrun on the downside” to between 585 and 780, and Hussman “hopes” for a bottom between 600 and 780. Bennet Sedacca (“Living on a prayer” and “What would it take for me to become bullish”) similarly has an index level of 500 to 600 in his sight.

In the meantime, the S&P 500 has been forming a so-called “descending triangle” since the middle of October. A triangle usually is a continuation pattern, i.e. when it occurs in a downtrend the break is usually on the downside. Based on technical analysis, such a breakout would imply a downside target of about 680.

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On the other hand, (as a good economist will say), if a downside breakout does not occur and we see a reversal to the upside, a strong countertrend rally could surprise investors.

Marc Faber, author of the Gloom, Boom & Doom Report, sees such an eventuality as follows:

… when based on some factors (technical and fundamental) a market is supposed to break out in one direction (up or down) and the breakout does not occur or fails, a very strong countermove usually gets under way. For what it’s worth, I covered all my short positions before Tuesday’s (November 4) almost 900 points rally [on the Dow Jones Industrial Index] and increased my equity exposure to 10% of my assets. I would consider a move above 900 for the S&P 500 to be a confirmation that a temporary low is in place.

However, Faber cautions:

… the call for a temporary rebound (lasting three to six months and up by 20% or so) does not imply that we have seen the ultimate low – although I would not rule it out entirely in nominal terms. But it is unlikely that we are even close to a major low in real terms! In fact, in real terms the market would seem to have further considerable downside risk.

The long-term inflation-adjusted graph of the S&P 500 Index is provided below, courtesy of The Chart Store. This rather ominous-looking picture shows that the real S&P 500 has already breached its 2002 low.

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Source: The Chart Store

Although the venerable Richard Russell (Dow Theory Letters) claims that “neither the duration nor the depth of a primary movement can be forecast in advance”, he does caution about the great false rally that followed the 1929 crash. Russell said:

That deceptive rally took the Dow in April 1930, back to within 60 points of the 1929 peak. Following the April peak, the market crumbled as the Great Depression started. In view of that example, I will be very careful and suspicious of any large-scale advance from here. The quality of any rally from here should be examined minutely for any discrepancies.

In short, stock markets seem to be on a knife-edge and the closing lows of October 27 (8,176 on the Dow Jones Industrial Index and 849 on the S&P 500 Index) are key levels on which to keep an eye. Suffice to say that extreme caution is still the recommended course of action.

 

Comments

[j_remington:]

The last shoe has yet to drop. Early bulls will panic sell to start the next wave of downside.

2008 Nov 12 08:39 AM

[investor88:]

Agree with Prieur's conclusion that "extreme caution is still the recommended course of action" despite all the bull talk by investing legends. The sp500 chart shown above appears to indicate sp500 of 500 pts eventually.

2008 Nov 12 08:47 AM

[Pipo:]

"Stocks markets in the West are still expensive on any historic valuation method" said Jim Rogers today in Seoul. But he is buyibg China and Taiwan.




www.jimrogers-investme...

2008 Nov 12 09:00 AM

[Consider_this:]

When nobody wants to be bulls publicly anymore; when there's no glamor to be labeled as a buyer -- that's when it's time to buy.

Right now, everyone wants to be famous trying to call the bottom.

Gamblers market: They might win, but it'll be from randomness than skill.

2008 Nov 12 09:47 AM

[bricki:]

Good luck calling a bottom. It could already be in or it could be 30% lower from here. Smart money doesn't try and accumulates over a period of time when we are down 40%.

The important thing is to have a position established when the recovery comes.

2008 Nov 12 10:56 AM

[Lilguy:]

I've have begun to re-invest in the market altho I expect it to continue to drop another 100 or so points on the S&P500.

My investments have been in high yield, low P/E companies that (a) have little debt, (b) have a promising business future (not GM), and (c) a record of steady (if not growing) dividends over an extended period (25 years or more). I am not expecting these companies to cut their dividends (altho their market value has declined) and, in the meantime, reap real returns greater than most fixed income alternatives.

2008 Nov 12 11:11 AM

[Jackson Cash:]

Let me save some fool countless dollars. If one goes long, have an exit strategy.

To save more dollars, do not buy and hold unless you want to lose another 50% in the next seven years.

If you wish to not do either of the above, simply send me your money, I'll take 30%, kick you in the ass and give you back your 70% whenever you want.

2008 Nov 12 11:46 AM

[aarc:]

Unless Dow Jones breaks above 11,000 before Q2-Q3 2009, the direction is clearly downward to 4750 target by Q3-Q4 2009.

This is using Elliott Wave analysis of the 100 year Dow Jones chart. Dow Jone is a high probability expanding flat on the monthly, quarterly, and yearly charts. This vicious downside plunge that started Oct 2007 is characteristically a C wave of an ABC expanding flat that started year 2000. C waves usually cover more price area (hence expanding) that breaks the A wave and consumes less time than the A wave. The plunge from year 2000 to 2002/3 is the A wave that consumed almost 3 years. This current C wave plunge should consume less time than that.

The complex pattern developing on the 120min and daily chart is a normal characteristic of a iv-th wave of a 3rd wave of a C wave. It may either finalize in either a triangle or a complex flat or even a double combination. iv-th waves and 4-th waves are extremely volatile and highly unpredictable and the terminal point can usually be found with high level of centainty after several "mistakes" and in most cases only when the v-th or the 5-th wave is already on its way.

At any rate, target for v-th wave of the 3rd wave of the C wave is still 7300-7500 on nominal basis. This is necessary to provide the divergence buy signal on the weekly chart in order to dissipate the excess momentum to the downside.

However, a relief rally to 9000-10000 from the 7300-7500 will only be able to dissipate the weekly chart momentum but not the monthly chart which will need the 5th wave down of the C wave target of 4750 nominal (assuming the 5th wave dont extend to 2393 or even over-extend to the 700-1000 area).

C wave of an expanding flat on the long-term charts can be killers. A recent example is MER which has an expanding flat on the monthly and quarterly charts that projects a target of $9.00 nominal. MER was consumed by BAC even before the pattern was consumated.

This DJ plunge could be a killer. Many stocks in the Dow Jones are projecting death spirals that will eliminate them from the list. However, who are going to replace them?

With the demise of the 5 horsemen of Wall Street (GS, JPM, MER, MS, and BS) who should be acting as the "white knight" in this current downturn; the fate of US stock markets is now at the hands of the government.

There is still a 20% to 30% chance of preventing an expanding flat since Dow Jones was able to form a 154% fibo price extension to 14200 Oct 2007 from 7200 of Oct 2002. Meaning the B wave formed from 7200 to 14200 possess some strenght in order to prevent a C wave from fully forming. This is called a C failure which happens when the 3rd of C got retraced more than 62%.

But 11,000 must be broken to the upside without 7200 getting broken to the downside. That will project a target of 16000 for a d:3 of a simple abcde running triangle on the quarterly chart.

That's it, pay the fine (ABC expanding flat) or pay the time (abcde running triangle) with ABC expanding flat almost all certain given the current conditions with no possible effective solution for this "once in a century" crisis on the cards for the rest of the year and into the H1 of 2009.

Govt has to do a "once in a century" solution which means something not done before by the Fed and/or the Treasury in the past. China's "once in a century" $600B solution is not enought unless the west do something really effective immediately. A drop to DJ 700-1000 area is catastropic to say the least. Why take the risk?

C wave of an expanding flat consumes massive acreage at an extremely short period of time. Time is the essence.

Hopefully, if 4750 holds, then a massive rally back to 14000 can happen in less than 5 years. An effective bullish expanding flat usually retraces the ABC within 50% of the time it takes for the ABC to form and in many cases consumes less time than the B wave (Oct 2002 rally to Oct 2007 consumed 5 years). C waves of expanding flats have less long-lasting effect due to the extremely short period of time it consumes . That is; a massive rally from 4750 will prevent most companies from declaring bankcrupcies due to the sudden turn of events and give them a new lease of life.

Only if the C wave dont extend or worse over-extend to the 700-1000 area. Like a knife plunging right into the heart of an ailing economy.

2008 Nov 12 12:25 PM

[investor88:]

Wyosteven has a point there, ie better to keep cash now. Aarc says there may be a trading opportunity from Dow 7k approx to Dow 9-10k.

2008 Nov 12 06:17 PM