Expecting a Rally? Three Reasons You Should Be

Since we don’t know how long the U.S. recession will last, how bad it will be, or where it will spread, it is virtually impossible to say when stocks will bottom. As a result, many investors are waiting on the sidelines, unwilling to add risk. At the same time, they expect a rally will take hold... eventually.

J.P. Morgan equity strategist Thomas J. Lee shares that view and sees the market ending higher by the end of the year. In terms of the timing, he expects a window will open up after mid-November.

The first reason he provides is that retests are the norm, with 86% of bottoms retested. Since many feel a low for U.S. equities was set on October 10 when the S&P 500 fell to 839 (intraday), which represented a 46% peak-to-trough decline, Mr. Lee said 25% of retests were passed by October 26. By November 23, 75% of the retest windows should have been passed. Meanwhile, the furthest out investors have to look to see if the October 10 low holds up is January 22, 2009, the strategist noted.

Next he looked at volatility, specifically, intraday volatility, which is calculated by subtracting the low from the high and dividing it by the close on a 20-day basis.

“High intraday volatility, in our view, sidelines major institutional investors,” Mr. Lee said. If current trends persist and intraday volatility continues to fall, it will fall below 3% after November 23. Meanwhile, its surge above 3% has been associated with the major lows of 1987, 1998 and 2002 “as it captures the panic, liquidation, and risk aversion needed to see a low,” he added.

Mr. Lee also pointed out that the 45-day redemption window for some investors who want out of hedge funds by year-end is November 15. This explains some of the selling we’ve been seeing and investors are understandably unwilling to add risk when there is such an imbalance of sellers.

As a result, the strategist said investors will likely wait out this window before adding risk. However, he noted that many hedge funds have 30-day redemption windows, which could make things worse.

Mr. Lee said:

Again, the reason this matters this year is the extreme volatility and correlation of assets have caused hedge funds to perform worse than in past downturns.

So resist the temptation and hold off for a couple more weeks because the rally will come, he added, reaffirming his year-end target for the S&P 500 of 1,125.

Comments

[thedozer:]

Economists possess an amazing ability to predict the future of market behaviors. but when my friend.

the beauty is, if you believed it, you were be there now and not on a keyboard!

2008 Nov 12 02:59 PM

[MarvinMBA:]

I would say we have to go thru a DEPRESSION before we can return to any possibility of a stock market improvement. I think it will take at least 5 years to pull out of this crazy economy which has been destroyed in the last 8 years. In fact my 5 year prediction might be too short so be prepared to hang in there and survive if you can. I think the Victory Garden will come back in favor and the old fashion street cars are going to be operating again...sure beats walking..MarvinMBA

2008 Nov 12 04:36 PM

[Carl Spackler:]

Wow! I will make a bold predicition too. There is a 50% chance that by December that stocks are higher and a 50% chance that they are lower. Please give me an analyst that does not hedge his bets. I want the buy at Credit Suisse that told their accounts to get out of the market early this summer because he predicted (note: he actually called for it) that stocks will go for a free-fall.

I will give you one - 725-775 S&P. It is that simple and it really is not hard.

2008 Nov 12 04:38 PM

[Mowog:]

Perhaps you mean Prof. Nourini Roubini? He called the current pain in 2007 and is, last I recall, predicting much worse.

2008 Nov 13 08:33 AM

[Urbane Gori...:]

Yawn! Another prediction.......Bill Kraft of MarketFn.com said it best.

Thx jegan '-)
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We hear and see so much in the media devoted to whether the markets have found a bottom and where the bottom might be, but the truth is no one knows. Prediction is little but speculation and has no value. In his excellent recent book, Beat the Market, Charles Kirkpatrick quotes commentator and chief market strategist Barry Ritholtz as saying the SEC should require all analyst and pundit forecasts to publish the following caveat: "The undersigned states that he has no idea what's going to happen in the future, and hereby declares that this prediction is merely a wildly unsupported speculation."

As Mr. Kirkpatrick notes in referring to David Dreman's research which studied 78,695 earnings forecasts by analysts over a 20 year period from 1973 to 1993 only 1 in 170 forecasts were within 5% of any four consecutive quarter's actual earnings. Why do we continue to rely on such speculation?

2008 Nov 13 04:42 PM