Lower Markets Are Still to Come

It's probably the last thing anyone wants to hear so soon after news of the 533,000 lost jobs lost month (announced on Friday) -- but if history is a guide, it's only going to get worse from here.

First, the market rallied 240 points on the much worse than forecast numbers Friday morning, and it appears that the Christmas season bear market rally may have a ways to go. Remember, bear market rallies can be incredibly powerful…much more so than even those in a bull market. Technically speaking, and that’s basically what this rally is, the Dow could go all the way back to 10,500 – 10,800 or so and we would still be in a bear market. I highly doubt this will happen, but the possibility remains. After the 1929 crash, the market had a rally so big that it convinced most people that the worst was behind us, only to ultimately see losses that wiped out 90% of the stock market from its 1929 pre-crash high. The point being, don’t let a bear market rally fool you…regardless of how high this short term move carries us, much lower prices are still to come. Again, more on this later…

President Elect Obama brings with him a great deal of optimism, but it must be at the chagrin of those that got him elected. He has abandoned his campaign pledge to raise taxes and his economic team and cabinet appointments have been on the ultra conservative side. Every time I see him giving a press conference on TV (which is about every day) I get a chuckle out of the sign on his podium…."Office of the President Elect"…it looks like something that Kinko’s did as a rush job.

No doubt about it though, the markets like him. When he speaks, the market goes up…it’s been one of the most reliable trades since the election. The only trade that is more reliable is when Bush, Bernanke, or Paulson speak, which generates a nearly guaranteed 200 point drop in about an hour. For those that enjoy shorting the market (in other words, those that have enjoyed making lots and lots of money over the last 5-6 months) you almost pray for a day when all three of these pinheads speak on the same day. A 500 point drop is just around the corner. Knut Rockne they are not.

Why This is Only a Bear Market Rally

The job losses from November are just the beginning. But don’t take my word for it. Here are the facts from Portfolio Magazine: The majority of job losses in the 11 previous recessions came in the second half of the recession. We're 11 full months into the current one and most forecasters think the recession will last through the end of next year.

Let's assume that's somewhere near the truth. Out of all the jobs that were lost during the average recession since 1945, 26 percent of them came in the first half and 74 percent in the second half. There've been 1.9 million jobs lost thus far in the current downturn, so the historical average would mean we could lose another 5.7 million jobs, for a total of 7.6 million by the end. That would be the most jobs lost during a post-Great Depression recession. I continue to forecast that before this recession/depression is over, unemployment will easily reach 15%, not close to the 25% unemployment of the 1930’s but unfortunately not at all far enough from it.

The chart below shows why we are in for a long painful recovery, and why everyone reading this should prepare themselves, their family and their business for the reality that will be 2009-10.

In past recessions, we had a savings rate of 10% plus to buffer the economy and household balance sheets. Because we have now had a negative savings rate for well over a year, with household debt of 127% to disposable income, there is simply nowhere to turn for much needed cash.

An important reason why the American economy has been so resilient and recessions so mild since 1982 is the energy of consumers. Their spending has been remarkably stable, not only because drops in employment and income have been less severe than of old, but also because they have been willing and able to borrow. The long rise in asset prices—first of stocks, then of houses—raised consumers’ net worth and made saving seem less necessary. And borrowing became easier, thanks to financial innovation and lenders’ relaxed underwriting, which was itself based on the supposedly reliable collateral of ever-more-valuable houses.

This is what has the Fed so concerned this time. No matter how much money they drop from helicopters, the money is not making it to the end-user…the consumer. The banks, with all of these obscene amounts heaped on them, are simply not lending, and as I’ve been reporting, credit card companies are now reducing and even canceling outstanding lines of credit. Credit card debt was the last thing supporting the average consumer, and this too is about to pass.

Remember folks, this very scary process is just getting underway…this is the deleveraging process that must follow the credit bubble we’ve just now said adios to, and I expect it to last a minimum of 12-18 months longer. In a consumer based economy (which is 70- 80% of our domestic growth), rather than a manufacturing based one, our economy MUST continue to shrink until the consumer returns to support it.

The Stock Market-Bottom Line

Anyone that feels there is a long term bottom in place is either one of the 30% taking anti-depressants of one kind or another, or is spending too much time watching the talking heads on CNBC. At least 80% of the so-called gurus they have on as guests continue to look for every opportunity to call a market bottom. Don’t believe them. As I wrote over a month ago, I continue to look for a class action lawsuit against CNBC and its efforts to pump the market higher artificially. Seriously, its attorneys must be telling the station the same thing is on the way. Anyone that’s listening to these gurus does so at great risk to his or her financial health. If you’re looking for some proof, just take a look at the losses these same experts have the full year. Almost all of these “portfolio managers” have losses of greater than 50% for 2008. That’s some kind of portfolio management, huh? With friends like these...

Having said all of this, there is still a fairly good probability of an Obama/Christmas bear market rally continuing our way. Only those with a strong heart may want to attempt to trade this kind of rally, but at the same time a 1000 point move higher in the Dow is possible. Hey, whenever a stock market can rally a total of over 500 points on the kind of unemployment numbers we got on Friday, anything is possible.

Very Favorable Seasonal Period

Yale Hirsch, who I had the great pleasure of dining with at New York’s Tavern on the Green some 15 years ago, is the founder of Smart Money and the Stock Traders Almanac. He noticed many years ago that virtually all the stock gains since 1950 came in the November 1st to April 30th period of the year. Starting with $10,000 in 1950, the November 1st to April 30th period produced a profit of $489,933 in the 55 year period starting November 1st 1950 and ending April 30th 2004. In comparison, the period from May 1st to October 31st produced a LOSS of $502 over the same 55 year period. This seasonality of the market is very hard to ignore. It’s also no accident that the majority of these gains came at a time when Congress was primarily NOT in session.

Commodities: Energy - Gold – Silver Update

Finally, all commodities continue to forecast deflation rather than inflation. Merrill Lynch is now looking for oil to hit $25/barrel before it’s all over and it may well be right, however I think a $40 floor is more likely. I have a new oil recommendation on the way, but it’s a bit early to make it public. Stay tuned however, because once the US dollar resumes its bear market, energy prices will reverse course quickly….even in the slowest of economies (remember, oil is priced in US dollars, so it must move higher as the dollar goes lower).

The same strategy applies to gold and silver, but for now it appears that the trend will continue lower. Robert Prechter, of the famed Elliott Wave Theory, has been forecasting a long-term deflationary environment for some time, and to date has been far more right than wrong. Of course, he’s also looking for the Dow to drop to 400 before this is all over. And some of you have called me too bearish….

Stock position: None.

Comments

[lucky lenny:]

On a more fundamental level, I just don’t see how Obama’s plan to drive up the national debt is going to fix anything. Let alone result in higher stock market values. If deficits were an economic cure, then how come we’re in a recession? Per Treasury’s web site, treasurydirect.gov...

- the debt under Prez GW Bush went from $5.7 trill to $10.0 trillion. What happens if interest rates start going back up? How are we going to afford the interest on $10 trill? Let alone the trillions more than Obama and the Democrats want to tack on? Just look at countries that run up continual deificits, e.g., the Argentine Peso or Turkish Lira. Their currencies suffer for it. In summary, more debt on top of our $10.0 trillion debut may feel good in the short run; however, it’s going to be terribly painful in the long run.

2008 Dec 08 08:22 AM

[herbert hoover:]

Please don't inject rationality into this irrational rally. Let the idiots buy. I have stocks to dump.

2008 Dec 08 08:44 AM

[Bhakta:]

I do not have a clue if the markets have bottomed. I see an awful lot of very good businesses being sold for next to nothing now. One would think that use of energy is going to cease altogether and everyone is going to stop eating, sleeping, mating and defending. Be careful, the darkest hour is just before the dawn.

2008 Dec 08 08:50 AM

[investor88:]

Agree with Kip's article which is that the broader trend is lower not higher. However, Dow 11k not out of the question as bear rallies are fiercer than bull rallies. Now we are in the Obama/Santa rally but since it is a bear rally use it to trade and not buy and hold.

Pretchter says Dow 400 before this is all over? Wow that is quite a forecast but it not out of the question simply because this is the peak of the 1929 Dow bubble. What's wrong with resting on the 1929 Dow super bubble as the support? In all seriousness, I don't buy this scenario Dow 400 but a 80% decline of peak Dow 14k to Dow 3k is possible. Major stock crashes have seen declines of 80% or more eg Nikkei 40k to 8k, China index 6k to 1.8k recently etc.

2008 Dec 08 08:59 AM

[RCA:]

It is, indeed, interesting that the market is showing signs of life. But don't put too much faith in any proclamation that the market has bottomed. It seems very likely to me that the DJIA will close out the year below 8000, and probably below 7400.

There is a popular notion that the market is ruled by greed and fear. As greed increases, the bulls gain control and the market rises. As fear dominates, the bears are out in force and the market falls. There are a couple of other parameters to this equation, however.

If you break the market into two distinct sectors, institutional investors and individual investors, it becomes apparent that the institutional part of the market is ruled by greed and caution, and the individual sector is controlled by hope and fear.

The institutions, being in greater control by virtue of size and amount of capital, also are privy to more information than the average individual. They therefore are not as susceptible to fear. They are greedy on the upside, and cautious, not fearful, on the downside.

Individuals are a very optimistic and hopeful lot. Their investment decisions are motivated more by hope and a belief that the "natural" state of affairs is a rising market. When it falters and breaks down, their hope gives way to fear. Unlike the institutions which are very pragmatic in their decisions, individuals are more emotional, and in a down market they become paralyzed by fear. That is why so many 401ks get wiped out in a market such as the one we have been experiencing.

What does all of this have to do with my feeling that the market is destined to be much lower at year end? My prediction is based on a belief that the recent rally in the market has been driven not by a lot of buying interest, but rather a lack of selling interest. The ever-hopeful individual investor still wants to believe in this rally, while the greedy institutions are quite willing to oblige this fantasy - for short while longer.

When you realize that the institutions, whose market commitments will always determine the market direction, are faced with a lot of "forced" selling between now an January, they have a vested interest in seeing the stock prices rise as much as possible before they put in their sell orders.

A simple way to accomplish this is to sit on the sidelines and let the small-money, the hopeful money, the imprudent money drive the market higher. By postponing their massive sales as much as possible, they are engineering a significantly higher market from which to extract as much as possible, and they are decoying the individuals into a belief that a real rally is under way. After a few more days of inaction, they will begin to put in their sell orders.

Since the institutions know when they are going to pull the trigger on their exodus, they might even be doing some buying in this bear market rally to capture some short term profits before the collapse. They are well positioned to fleece the small money on the way up before they shear them on the way down.

If this scenario plays out the way I think it will, we will rally the first part of this week. Then you will see a market that goes sideways for a few days, and then a decline will become obvious. At first it will seem like normal profit taking. After all, the pundits will say, it is perfectly normal in a rally for investors to claim some of their profits and take a look at new opportunities -- new stocks and sectors which may being showing leadership, etc.

Then the selling will ramp up to the point that it overwhelms the buyers, and we will see another precipitous decline, with the Dow undercutting 8000, and perhaps going much lower than that.

There are at least three reasons why heavy institutional selling is in the cards for December:

1. The hedge funds have a lot more redemptions coming before January. The hedges are not anywhere near normalization yet. In the interest of disclosure, I have to state that this assertion is more hypothesis than fact. I do not no have any figures on what reclamations are lurking. My gut feel is there are still quite a lot.

2. The mutual funds need to get their losers off of their prospectuses before the end of the year. And they have been holding lots of losers! It is a particularly cynical practice in the industry to hide a losing year or quarter by showing a raft of good stocks in their stable when a snapshot is taken of their holdings. Never mind that most of the quarter they were in losing positions, as long as the snapshot doesn't show these losers, they can actually look like they are well on their way to making money for their investors.

3. Year-end tax selling by many investors, large and small. There are many investors who have lost a lot of money this year, and the only way they can deduct those losses on their income taxes is to actually realize the losses. In other words they will be highly motivated to sell their big losers to establish their losses.

When the year-end selling hits, the hopeful individuals will be caught off guard again. Their hope will diminish and fear will again dominate. They are being groomed right now to grow the market so that it can be more profitably harvested by those in control of the market.

At some point we will see a true capitulation (we haven't seen it yet). When we do see it, it will be unmistakable. There won't be anyone asking "Is this the capitulation?" because it will declare itself loud and clear. The year-end selling will cause the markets to collapse, and the worsening economy will almost guarantee that climbing up from the capitulated bottom will be long and arduous.

2008 Dec 08 09:07 AM

[jdl51:]

Anyone that relies on what some commentator says on TV deserves to lose their money. I've discovered over the years that with ten different commentators/experts you'll get ten different opinions on what is happening. Basically your guess is as good as theirs. If there should be a class action lawsuit, you should probably start with the administration. It was on their watch that the banks, mortgage brokers, appraisers, securities bundlers, rating agencies, CDS markets went completely out of control. The SEC, Treasury and FED all stood by watching this disaster unfold and did nothing, not to mention the almost tripling of the national debt by this administration by the time their last budget rolls out. There's a lot of blame to go around, but the last place I'd look is a bunch of talking heads on CNBC.

2008 Dec 08 10:33 AM

[Kip Herriage_:]

i agree with your targets....pretty much where i am long term, especially if the govt continues to muck things uo


On Dec 08 08:59 AM investor88 wrote:

> Agree with Kip's article which is that the broader trend is lower
> not higher. However, Dow 11k not out of the question as bear rallies
> are fiercer than bull rallies. Now we are in the Obama/Santa rally
> but since it is a bear rally use it to trade and not buy and hold.
>
>
> Pretchter says Dow 400 before this is all over? Wow that is quite
> a forecast but it not out of the question simply because this is
> the peak of the 1929 Dow bubble. What's wrong with resting on the
> 1929 Dow super bubble as the support? In all seriousness, I don't
> buy this scenario Dow 400 but a 80% decline of peak Dow 14k to Dow
> 3k is possible. Major stock crashes have seen declines of 80% or
> more eg Nikkei 40k to 8k, China index 6k to 1.8k recently etc.

2008 Dec 08 11:43 AM

[Kip Herriage_:]

excellent comments here. This is a technical rally and the ultimate capitulation is going to hit people like a ton of bricks.


On Dec 08 09:07 AM RCA wrote:

> It is, indeed, interesting that the market is showing signs of life.
> But don't put too much faith in any proclamation that the market
> has bottomed. It seems very likely to me that the DJIA will close
> out the year below 8000, and probably below 7400.
>
> There is a popular notion that the market is ruled by greed and fear.
> As greed increases, the bulls gain control and the market rises.
> As fear dominates, the bears are out in force and the market falls.
> There are a couple of other parameters to this equation, however.
>
>
> If you break the market into two distinct sectors, institutional
> investors and individual investors, it becomes apparent that the
> institutional part of the market is ruled by greed and caution, and
> the individual sector is controlled by hope and fear.
>
> The institutions, being in greater control by virtue of size and
> amount of capital, also are privy to more information than the average
> individual. They therefore are not as susceptible to fear. They are
> greedy on the upside, and cautious, not fearful, on the downside.
>
>
> Individuals are a very optimistic and hopeful lot. Their investment
> decisions are motivated more by hope and a belief that the "natural"
> state of affairs is a rising market. When it falters and breaks down,
> their hope gives way to fear. Unlike the institutions which are very
> pragmatic in their decisions, individuals are more emotional, and
> in a down market they become paralyzed by fear. That is why so many
> 401ks get wiped out in a market such as the one we have been experiencing.
>
>
> What does all of this have to do with my feeling that the market
> is destined to be much lower at year end? My prediction is based
> on a belief that the recent rally in the market has been driven not
> by a lot of buying interest, but rather a lack of selling interest.
> The ever-hopeful individual investor still wants to believe in this
> rally, while the greedy institutions are quite willing to oblige
> this fantasy - for short while longer.
>
> When you realize that the institutions, whose market commitments
> will always determine the market direction, are faced with a lot
> of "forced" selling between now an January, they have a vested interest
> in seeing the stock prices rise as much as possible before they put
> in their sell orders.
>
> A simple way to accomplish this is to sit on the sidelines and let
> the small-money, the hopeful money, the imprudent money drive the
> market higher. By postponing their massive sales as much as possible,
> they are engineering a significantly higher market from which to
> extract as much as possible, and they are decoying the individuals
> into a belief that a real rally is under way. After a few more days
> of inaction, they will begin to put in their sell orders.
>
> Since the institutions know when they are going to pull the trigger
> on their exodus, they might even be doing some buying in this bear
> market rally to capture some short term profits before the collapse.
> They are well positioned to fleece the small money on the way up
> before they shear them on the way down.
>
> If this scenario plays out the way I think it will, we will rally
> the first part of this week. Then you will see a market that goes
> sideways for a few days, and then a decline will become obvious.
> At first it will seem like normal profit taking. After all, the pundits
> will say, it is perfectly normal in a rally for investors to claim
> some of their profits and take a look at new opportunities -- new
> stocks and sectors which may being showing leadership, etc.
>
> Then the selling will ramp up to the point that it overwhelms the
> buyers, and we will see another precipitous decline, with the Dow
> undercutting 8000, and perhaps going much lower than that.
>
> There are at least three reasons why heavy institutional selling
> is in the cards for December:
>
> 1. The hedge funds have a lot more redemptions coming before January.
> The hedges are not anywhere near normalization yet. In the interest
> of disclosure, I have to state that this assertion is more hypothesis
> than fact. I do not no have any figures on what reclamations are
> lurking. My gut feel is there are still quite a lot.
>
> 2. The mutual funds need to get their losers off of their prospectuses
> before the end of the year. And they have been holding lots of losers!
> It is a particularly cynical practice in the industry to hide a losing
> year or quarter by showing a raft of good stocks in their stable
> when a snapshot is taken of their holdings. Never mind that most
> of the quarter they were in losing positions, as long as the snapshot
> doesn't show these losers, they can actually look like they are well
> on their way to making money for their investors.
>
> 3. Year-end tax selling by many investors, large and small. There
> are many investors who have lost a lot of money this year, and the
> only way they can deduct those losses on their income taxes is to
> actually realize the losses. In other words they will be highly motivated
> to sell their big losers to establish their losses.
>
> When the year-end selling hits, the hopeful individuals will be caught
> off guard again. Their hope will diminish and fear will again dominate.
> They are being groomed right now to grow the market so that it can
> be more profitably harvested by those in control of the market.
>
>
> At some point we will see a true capitulation (we haven't seen it
> yet). When we do see it, it will be unmistakable. There won't be
> anyone asking "Is this the capitulation?" because it will declare
> itself loud and clear. The year-end selling will cause the markets
> to collapse, and the worsening economy will almost guarantee that
> climbing up from the capitulated bottom will be long and arduous.

2008 Dec 08 11:45 AM

[SeekingTruth:]

Overall, I couldn't agree more. I think 6000 t0 8000 is highly probable, and possibly lower. RCA's views also make good sense, reflect many of my own views, and are well worth considering. but good sense seldom drives the markets as your article clearly points out. Event risk is also ever present, and could make a bad situation much worse.
Could you please let us know in what article you explained and justified the Dow drop to 400?

2008 Dec 08 11:58 AM

[SeekingTruth:]

Upon re-read, you obviously meant that only Prechter was predicting a Dow drop to 400, Sorry for the initial mis-read.

2008 Dec 08 12:46 PM

[Smarty_Pants:]

Nobody can be an all-knower,
With the economy running much slower,
Though Traders might sally,
Forth in bear market rallies,
Buy 'n Holders could wind up much lower.

2008 Dec 08 02:14 PM

[pairadox:]

The current rally reminds me of the October 2007 buying frenzy, when the market peaked in the face of horrendous news. Banks reported multi-billion dollar losses, and talking heads said they were "coming clean", the financial crisis was over; but economist were telling us the worst had yet to begin. When GW, the king of spin, says, "Hey, guess what? We've been in a recession," I worry, that we may be careening toward depression.

2008 Dec 08 07:14 PM

[Blair:]

My put is that a good selling point from a timing consideration is the inauguration.

The principal consideration is that no-one in the government can turn this economy around in a short time. What is going on is will take a considerable amount of time and nothing can be done to reduce this time requirement.

The most important point to be made, which may help with what one should do regarding investments, is the 2 generation change in mindset.

What you are seeing is a reversal of a mindset that started in the 1960s, specifically, with regard to responsibilities. That all of the great things in life are free. Houses, SUVs, great vacations, etc. One will never have to pay for them - housing prices will go up forever and you can always get another equity loan, for example.

From a generational consideration, the baby boomers had children, and these children accepted (why not?) what their parents had told them. So that brings us up to the 1980s. Now those second generation children are having children, who were told that they too could have the great life style. Etc.

So, what is going one is a revision to the real economic world.

To beat the horse real dead, what needs to be cleaned up are two (if not more marginally) generations of a mindset.

I think that this picture now gives an investment forecast. For the indefinite future, the name of the game will be more conservative investments, if for no other reason there isn't any easy money around.

So, keep your money in a capital preservation mode to take advantage of the upswing when it occurs.

2008 Dec 13 04:42 PM

[31October:]

The author is correct in the reasons.

But, unless there is a global incident, markets will head up in 2009. The debt of the USA is like an apatasaurus strapped to a rocket (unimaginably huge, but shooting higher anyway. Trillions of non-existent virtual money is being created. Treasury, the Fed, and Congress want this inflation to happen. Otherwise, they cannot service the debt, let alone increase it. Otherwise, all the debt and preferreds and other junk they bought from AIG, GS, GM, et.al are worthless. Otherwise, Japan & China would have no reason to support the dollar any more.

The latent inflation could be temporarily masked. Most allocated bailout funds have not been distributed. When they do receive the so-called money, banks will be gun-shy and leave it in the FED to collect interest (another FED error.) Homeowners can no longer buy beer and toys on HELOC cards, and layoffs are increasing. Demand thus drops further, and people hear that it's time to hoard cash, further reducing money flow. But the deflation is a farce. As soon as housing seems to bottom, the banks & hedge funds will forget what got us here. When institutional investors hit the market, it will go up. The fake money will be invested, flooding the M2 and making the numbers look great before inflation numbers catch up. Individuals will think that the debt-induced increase in numbers is good, they will forget what the banks & hedge funds do for a living, and they will also invest.

If I am wrong about the reduced velocity of money and the deflationary effect, then inflation jumps in sooner. Again, people would misinterpret those bigger numbers as a good thing, right on top of the current technical rally. Eventually, inflation is going to be freakishly large. I hope the markets stay down. The more markets go up, the worse the fall when reality kicks in. A bull market could run for months, but the fundamental problems in the American financial system, especially with government “help,” mean that it will make everything worse.

Markets should not go up just because the world is flooded with useless, fake, nonexistent money. But they will, for a while.

Jan 15 12:28 PM