Inspiring New Leadership Could Transform Market Blues

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (November 24th):

...the dour economic backdrop has caused analysts to lower their earnings forecasts on companies to the point whereby only 222 companies in the S&P 1500 have seen their earnings estimates increased. Obviously, this decline in earnings expectations has a caused a recalibration of P/E multiples with an attendant “hit” to stock prices. And last week that “hit” caused the S&P 500 to fall to its lowest closing level since April 1997, while other U.S. indexes set 5½-year lows. Moreover, the Wilshire 5000 index, the broadest measure of the U.S. markets, has now fallen by more than 50% since its peak 13 months ago; and Treasury yields also fell to record lows with the 30-year U.S. Treasury bond declining to lows last seen in the early 1960s.

Interestingly, the combination of lower stock prices and higher Treasury prices caused the dividend yield on the S&P 500 to exceed the yield on the 30-year Treasury bond for the first time since 1958. That means that a shareholder of the S&P 500 needs NO capital gains to outperform the holder of long-dated government bonds. And maybe, just maybe, those valuation metrics are what caused Vivan Watsa, CEO of Fairfax Holding (FFH) and one of the few investors who have played this downturn to a tee, turning $500 million into more than $2 billion in the past year, to remove all of his downside stock hedges. Specifically Mr. Watsa stated:

Given the unprecedented decline of the equity markets during the past several months, we felt it was prudent to promptly inform our shareholders that we closed out our equity index total return swaps this week and effectively eliminated our equity portfolio hedge. While we believe the recession may be long and deep, we also believe that stock prices may have already discounted the worst of the economic decline. As value investors, we are finding an incredible number of investment opportunities across the world.

...last week the DJIA slid below its October 10th low of 7882 that I had expected to mark the short/intermediate “low,” thus activating downside targets between 7200 (approximately the 2002 low) and 7500 (50% retracement of the 1982 to 2007 Dow Wow). And, on Thursday and Friday of last week the DJIA traveled well into that target zone, leaving only 13 stocks in the S&P 500 above their respective 200-day moving averages, and extremely oversold, as can be seen in the chart on page 4 from our friends at the invaluable Thechartstore.com. The Wednesday through Friday morning swoon lopped 1000 points off of the senior index, leaving participants in “crash mode,” but Friday afternoon ushered in the “Geithner Gotcha.”

For the last few weeks we have suggested that President-elect Obama could either adopt the FDR model, which would be disastrous for the economy and the markets, or he could step-up and provide leadership to fill the current leadership vacuum. Again as the GaveKal organization opined:

Probably most important economic transformation which is about to occur is the transformation in personal leadership. Suppose you believe, as I do, that the financial meltdown triggered by the bankruptcy of Lehman Brothers was not a divinely ordained retribution for decades of greed and profligacy, but simply a bizarre accident, caused by the incompetence of the Bush Administration, particularly of Mr. Paulson. In that case, the arrival of a credible new economic team in Washington, led by respected figures such as Messrs Volcker, Summers and Geithner, could transform psychology in global financial markets. With house prices stabilizing and an inspiring new leader replacing the doltish President Bush, American consumer and business confidence could enjoy a similar resurgence.

And, that appears to be precisely what happened late Friday. Hopefully, that mindset will continue this week.

The call for this week: We still think October 10th represented the capitulation “lows,” as can be seen in the S&P 500 chart on page 4 that shows the RSI and MACD indicators at their most oversold levels since the 1982. As Barron’s notes,

For a bullish spin, though a weak one, the market has not made a significantly lower low since Oct. 10th. The word ‘significantly’ is important because some major market indexes, including the Nasdaq, have indeed been setting new lows. But the trend, if we can call it that, has been more sideways than decidedly down. A better, but still weak, bullish angle comes from trading volume, or the amount of money committed to either the bull or bear side each day. All of the higher volume days that have occurred since Oct. 10 have come on days when prices rose. Theoretically, when prices are going up and volume increases, it means that investors are chasing the market higher. That’s a sure sign of demand. Subsequent declines occurred with lower volume, so we can conclude that the desire to sell was not quite as strong as it was before Oct. 10th.

And don’t look now, but cold weather has crept into the country, which should be positive for the energy stocks we have been recommending.

Comments

[Smarty_Pants:]

"Suppose you believe, as I do, that the financial meltdown triggered by the bankruptcy of Lehman Brothers was not a divinely ordained retribution for decades of greed and profligacy, but simply a bizarre accident, caused by the incompetence of the Bush Administration, particularly of Mr. Paulson. In that case, the arrival of a credible new economic team in Washington, led by respected figures such as Messrs Volcker, Summers and Geithner, could transform psychology in global financial markets."

What are they smoking over at GaveKal? Have they missed the fact that a recession has just started and will likely get much worse before it gets better?

Those billions of acknowledged and trillions of level 3 losses waiting to happen are real money, not a 'mindset'. People are actually losing houses and jobs in droves. To them it's not a 'mindset', they're wondering how to make ends meet today.

Messiahs on tv may make your spine tingle, but it's not putting food on their tables or roofs over their heads any faster.

2008 Nov 25 02:23 PM