Saut: When Stocks Ignore Bad News, That's Good News

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (December 8th):

Speaking to the equity markets, I said it again on CNBC last week while standing on the floor of the NYSE:

"First, until proven wrong, I continue to think October 10, 2008 represented the ‘capitulation low’ when of the 3,130 stocks that traded on the NYSE, a shocking 2,901 (or 93%) of them made new yearly lows. Subsequently, even though all of the indices we follow have registered lower prices since October 10th, NONE of those lower lows have been accompanied with anything close to the new yearly low ratio that occurred on October 10th!

Second, while the S&P 500 (SPX/876.07) traveled below its 2002 ‘low,’ the DJIA (8635.42) did not, and that’s a huge downside non-confirmation. Third, I can find nowhere in history w[h]ere the major averages have declined by 50% and there has not been a major ‘throwback rally’ even if the averages eventually went lower. And fourth, I’ve learned the hard way that it is extremely difficult to put stocks away to the downside during the ebullient month of December."

Consistent with these thoughts, we have continued to recommend that accounts position themselves accordingly; and more importantly, not be heavily “short” of stocks, even though that is “The Street’s” current de rigueur. Verily, for the first time in my 10-year stint at Raymond James I can finally say that stocks, in the aggregate, are “cheap.” Cheap on a price-to-earnings basis, cheap on a replacement value basis (Tobin’s Q), cheap on a cash flow basis, cheap on a dividend yield basis, and the list goes on.

Further, followers of our work know that since July, when correlations that have worked for years ceased working, we have likened the environment to that of the 1937 – 1938 stock market decline. Like now, there was nowhere to hide in 1937 except cash, Treasuries and/or “short” of stocks. Also like now, the authorities did everything in their power to stem the stock slide. Unfortunately, none of their attempts worked until the DJIA had lost nearly 50% of its value and there was nobody left to “sell.” Hopefully, that is where we are currently. And while history doesn’t necessarily repeat itself, it does often rhyme.

To this point, we have included in this morning’s report a chart comparing the 1937 – 1938 affair with 2008. Of note is the strikingly close correlation. Also worthy of consideration is the next chart from our friends at thechartstore.com, which shows that there have been only two other periods since 1928 when the difference between the lower band and the 40-week moving average [WMA] divided by the 40-WMA exceeded -30% while both were going down. Those periods were from October 1931 to July 1932 and from December 1937 to April 1938. Interestingly, July 1932 marked the DJIA all-time “low” of 41.22, while April 1938 marked the end of the vicious 1937 – 1938 bear market.

In conclusion, it’s been said, “When stocks ignore bad news that’s good news;” and last week stocks ignored bad news! Therefore, we told institutional accounts early Friday morning, on the dour employment statistics, that “The early morning weakness was likely a buying opportunity.”

Accordingly, even though one of our mantras is to NEVER do anything on a Friday, we advised said accounts to “buy” positions in the ProShares Ultra S&P 500 (SSO) levered two-to-one on the upside, to buy the Direxion ETFs (TNA) levered three-to-one on the upside basis the Russell 2000, and to buy the ProShares Oil&Gas (DIG) levered two-to-one on the upside, all of which were recommended with the appropriate “downside hedged” option strategies so often mentioned in these reports. Obviously that hedging strategy looked pretty “stupid” by Friday’s closing bell; still, we continue to invest, and trade, accordingly.

The call for this week: We think last week’s early downside stock “stutter step” was attributable to Monday’s collapse in China’s currency, which the astute GaveKal organization suggests was a potential “warning shot” for the world’s economies with ominous implications (you can read about the implications in Saturday’s Financial Times).

Our sense, however, is that said currency collapse was merely a shot “across the bow” for Treasury Secretary Paulson’s China visit. If so, the near- to intermediate-term “lows” are “in” and the fabled Santa rally has begun. That view will gain traction if the DJIA can better its November 4th reaction “high” of 9625.28 with a confirming move by the D-J Transportation Average [TRAN] above its November 4th “high” of 4071.81.

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Comments

[Jack Walker:]

Jeffrey,

We wrote yesterday about the market’s reaction to the bad news. We would like to add it in further support of your article.

Last Friday’s equity market trading reminded us of this old Wall Street saying,

“The market bottom is defined when it stops going down on bad news.”

Recall last October the equity markets were still going down on what should have been considered good news with respect to the actions that were being taken by the Treasury and Federal Reserve to rescue the credit markets and the financial sector.

While there could be many explanations why the equity markets ended the day higher and not lower on the bad news, including short covering on the widely expected bad employment report. We also wonder if there is another possible answer like the one raised by Richard Russell last October when he said:

"Bear declines end in only one way -- in exhaustion."

Has most of the selling been done and could we be near the exhaustion point? Friday’s market action raises this possibility.


Jack

2008 Dec 09 11:03 AM

[RCA:]

On Dec 09 11:03 AM Jacktrader wrote:

> Last Friday’s equity market trading reminded us of this old Wall
> Street saying,
>
> “The market bottom is defined when it stops going down on bad news.”

Hmmm... the old Wall Street saying I remember is,

"The market bottom is defined when it fails to rally on good news."

The logic is that when even good news can't raise buying interest, we have exhaustion which confirms the capitulation. There is a wide-spread misconception about the meaning of capitulation. Many people and pundits think it is when we have a large downdraft in stocks, and indexes find new lows.

That is a necessary occurrence, but not a sufficient one for a complete capitulation.

Capitulation occurs during and *after* the downdraft, when the majority of market participants just throw up their hands in dismay, throw in the towel, and say, "I'm done!" After capitulation, the market languishes and even good news can't make it smile.

> "Bear declines end in only one way -- in exhaustion."

Exactly. The market is exhausted of energy and the market participants are exhausted trying to fight the downward trend.

The current generation of investors has been conditioned, thanks in large part to the Internet (and also to a pervasive herd-mentality of short-term thinking), to believe that things always happen in Internet time, and events have the longevity of a sound-bite. "OK, the market has bottomed, we can check that off the list. Now we will rally."

The "real world," however, (as opposed to the virtual world that has become the new shibboleth) does not operate like that. We are currently in a bear-market rally, and we have not yet seen the capitulation. Those who feel strongly that we have, will soon be parted from their money.

The economy is getting palpably worse every day, every hour! Do you really think that the companies you are investing in are going to prosper near term? Massive layoffs have been announced and more will come soon. Retail is in the doldrums. Manufacturing has all but ground to a halt. International trade simply is not happening. Foreclosures are causing even safe and sane mortgage borrowers to be upside down in the homes.

All of the recessions and downturns in recent memory have been "bailed out" by consumer spending. Today's circumstances are far worse than any of the others until you go back to the Great Depression. And the outcome will be much worse, and last much longer because (I hate to break it to you, but...) the consumer will not be carrying the economy on their backs this time.

Too many consumers have lost and will lose their jobs. Too many consumers are already mired in debt and consumer credit is drying up. Too many consumers have witnessed a major loss in their retirement portfolio. Too many consumers have seen their home equity evaporate.

A report on NPR this morning detailed the problems that a large wholesale clothing distributor in NY is having. They have a warehouse crammed full of top line suits, shirts, slacks, and other apparel that they can't move. They normally supply major retailers with this merchandise, but within the last three weeks, five of their seven largest customers have cancelled orders and say they will not be buying anything for at least a month, maybe longer.

Do you really think that we can spend our way to prosperity this time? What fairy tale events are you perceiving that are going to magically produce profits for companies that are retrenching and not conducting business?

Although my words may seem harsh, I offer this rebuke respectfully and this admonishment gently because my beliefs are not doctrine. I admit the possibility that I could be wrong. But I fear that I am right.

2008 Dec 09 12:57 PM