Today's Market: Irrationality at Its Best

With all the carnage taking place in the market, I thought it is time to put the insanity in perspective. For now one thing is certain: The consensus trade is to be short the market and for other long only institutions to sell down their positions as appetite for equities has dramatically diminished.

One reason for this phenomenon is that people believe that S&P earnings are still too high for 2009 and need to come down. The consensus estimate hovers around $60 with some strategists pulling down their numbers to as low as $49. So, the magic 600 S&P number is arrived at by putting a 12 times earning multiple on the $49 number and there you have it: S&P at 600. This is what the media and other pundits are tom-tomming about!

However, let us put things in perspective. Would you agree that in 2009 we are better off than we were in 2008? I certainly do. For one thing, we now have a much more actionable plan to shore up our financial institutions. Couple that with the stimulus package, and you have a catalyst to jump-start our economy.

Now, with all the pessimism abounding, people have thrown the stimulus plan out of the window and nobody believes that the plan to stabilize the financial system will work. As markets overextend on the upside, they almost always overcompensate on the downside. I think we have to recognize that 2009 is going to be a trough year for earnings, and there should be meaningful recovery in 2010 and 2011.

Fact of the matter is that the global economic system is too big to fail. I think we are seeing unprecedented cooperation amongst nations globally to stymie this crisis. I would have felt much more uncertain in 2008 with all the negative news and the collapse of the financial markets.

Think about it for a second: As I write, the S&P is down approximately 17% YTD and we are only in February. The S&P finished down 38% last year and we have almost reached half that level in the second month this year. Is this run-rate sustainable? Absolutely not!

What you are witnessing is irrational selling. Fear has encompassed the market and when that happens it becomes impossible to separate fact from fiction. The trend is obviously down and a good trader never wants to fight the tape!

However, when you completely discount near-term stimuli, the possibility for an explosive rally becomes all that probable. At current levels, the S&P has gone back to 1997 levels. There is doom and gloom in the market which also represents capitulation and the possibility of reversing the trend up.

Current action is making me very positive on the possibility of an explosive rally developing shortly.

Comments

[Maxe Paul:]

I think we will see a bottom in March of around 666 in the S&P, a rally will then be sustainable. If the second half recovery occurs then this would be a bottom, if the depression plays out, a further low will occur around October.

Feb 24 07:34 AM

[LaughingTrader:]

What this market needs is for President Obama and his minions to stop the doomsday rhetoric. I am very tired of hearing him say "it's going to get worse before it gets better", which is a phrase he utters virtually every time he gives a speech about the economy. It's like the late 70s all over again with President Carter's doom-and-gloom talk. Tonight the president will give a 1.5 hour speech which I fully expect will further depress the markets on Wednesday unless he starts showing some optimism. He fought hard for the stimulus package and he got it, so now is the time to talk about "turning the corner". He needs to show that he is confident that the actions they have taken will have a quick and positive effect on the economy. He needs to dig up any and all good news that he can find among thes carnage and present it as proof that things are poised to get better. In short, he needs to use "the bully pulpit" to inspire and lead, not to lecture and depress.

Feb 24 07:51 AM

[redbaron:]

Good article, and good comments by Maxe and LT above. I agree with both the article and the comments. I just hope we are all correct.

Feb 24 07:58 AM

[lex:]

why didnt u use consensus of $60? 60x12 =720

Feb 24 07:59 AM

[Steven Hansen:]

great. let us all celebrate the bottoming of the market in a circle jerk. i am amazed that people cannot grasp the size of the economic meltdown we are facing.

i am not predicting the market is going to fall - but i am predicting these ignorant claims of bottoms or the sun shining out of peoples orafices will soon be revealed as ignorant hype.

Feb 24 08:05 AM

[pacman1947:]

David,
Good article, that.
All my trading models say "Sell, sell, and short!" and my heart is not in it anymore. Widows and orphans funds are now down over 50% while invested in America's strongest companies collectively sitting on over $100 billion in cash (stuff like Apple, Microsoft, Cisco, and Intel). Pension funds that invested in Ponzi schemes are wiped out, but conservative long-range investors are not far behind. These are unleveraged assets invested for the long haul, and they are paying a terrible price. The USG wants to bail out the banks by buying their stock?!? Huh?!?

How was all this carnage caused by illegal aliens making a quick buck by selling mortgages to their fellow illegal aliens so they could stuff 7 families in a house? Do you believe all this crap? Do you think manipulation may have more culpability? Ya think?

I have my doubts about the Pubs and their crusade to discredit Obama and the Dems, but they caused this mess all by themselves according to the progressives. They all had some help.

Somebody is manipulating the entire system. It would be good if we followed Germany's Merkel and the EU and put the clamps on the Hedge fund traders. Maybe we will see who is really causing the trouble.

My computer alarms just went off again. "Sell, short, sell!" The indicators are 20% out of bounds. There is no floor under the averages for a long way down. This is a tough call. Should I follow my head or my gut?

Feb 24 08:16 AM

[words from ...:]

I would NOT agree that we are better off in 2009 than in 2008. Did anyone seriously believe--even in October--that today all 3 auto makers, our 2 largest banks, and our largest insurance company would effectively be kept alive by the gov't? And this is just the tip of the iceberg--which is sailing toward us from Japan, the U.K., Eastern Europe and a host of other countries that are well below the "recession" line. The world's banking system is effectively insolvent. When George Soros and Paul Volker say that the decline is steeper and quicker than in the Great Depression, and the PM of the U.K. says his country is in a depression (and his aid says it's worse than the Great Depression) shouldn't we be concerned? Are they so out of touch? Obama is just doing his job: managing expectations. (And apparently most agree with his approach, as today's NY Times poll says even Republicans overwhelmingly agree with his approach.)

Feb 24 08:18 AM

[wdhalgren:]

Investors have grown accustomed to brief recessions, accompanied by brief dips in the stock market, followed by government fiscal and monetary stimulus, and then a rapid rebound and it's off to the races again. You seem to be leaning that way again. It could happen, but we may be better off if it doesn't play out that way.

This is a crisis of too much debt. There are only two solutions, pay down the debt or inflate away the debt. If we choose to pay it down, then we are looking at a prolonged economic contraction during which the stock market will probably go sideways at best. Stocks are certainly not acting irrational if that is the scenario that occurs.

The other solution is to make the pain of all this debt go away with a wave of the government's hand, i.e., inflation via printing press. It's quicker, debt becomes manageable, fewer unsightly bankruptcies, no panicky shareholders because the stock market returns to the old familiar trading patterns. Every coroporation has a visible goal again; lobby the government for a competitive advantage, something they already know how to do well. Solution #2 seems so comforting. We've learned to love our easy money. This seems to be the path you foresee and I don't necessarily disagree.

One minor thing to keep in the back of your mind as the warm narcotic of fiat money once again flows through the arteries of this system. There is nothing about printing money, or excessive credit, or government largesse and power, that create more wealth. Wealth is created by individual persons working hard to better themselves. All those stories about "pump priming" and "paradox of thrift" and future "fiscal responsibility"...., rationalizations used by addicts to justify one more score. Just get us through this rough patch, make us feel better again, and then we'll have our mind right for the hard work of going straight.

If you're hoping for a quick market rebound, be careful, even if it helps your personal situation in the short term. This may be the dose that finishes America off.

Feb 24 08:28 AM

[sieraromero:]

2009 better than 2008? You have to be kidding! I want some of your kool aid in these stressing times. The economy is a mess and it IS getting worse and worse by the day. Wishfull thinking, and hopes and dreams and talking up the economy and saying it is unpatriotic to face reality and admit our problems and facing them will not get us out of this economic mess. We don't need a cheerleader and magic fairydust to pull us out of this delima we find ourselves in. We need to see what are the problems,acknowledge them and work to fix them! This administration is attempting that. Even though I don't agree with his actions entirely, especially the mortgage fix, he is trying to turn it around. Good Luck to you all as you will need it!

Feb 24 08:42 AM

[kirkf:]

Until I see the USA begin targeting their debt as their most pressing economic problem, I simply dont see a turnaround.

Luckily I am starting to see the signs with your new president at least talking about halving the deficit. However until he starts raising taxes and cutting government spending thats all just rhetoric.

Until your own government starts putting policies of fiscal responsibility in place why would you expect your major corporations to act differently?

We have been through this in Canada after 1992. It was a long and painful process. If you spend beyond your means, one way or another you have to pay the piper.

Kirk

Feb 24 09:13 AM

[Roger Knights:]

"The S&P finished down 38% last year and we have almost reached half that level in the second month this year. Is this run-rate sustainable? Absolutely not!"

Never say Never.

Feb 24 10:28 AM

[pungent:]

David, I have a MarketWatch article on my office wall from several months ago asking "Was that the bottom?" I'll be putting your article up right next to it. We are not done with this thing yet and the market is flushing all of the toxic stupidity out of its system. That's gonna take a while. We haven't even begun to assess the cost of the foolishness in corporate real estate. You do realize the rot in that market is probably LARGER than the current real estate bubble -- right?! This is why GE and others will be bleeding from the eye sockets before this is all over.

Now close your eyes, click your heels 3 times and say
"Prosperity is just around the (maybe FY2013) corner.

Feb 24 10:35 AM

[Fred Voetsch:]

This polyanish garbage is not even worth commenting on. Read my other posts to see tons of reasons why the stock market is going to 3,000 before it turns around. My reasons are based on stats, history (beyond the last 20 years) and hard, verifiable data along with the reserach of experts who have been right all along about this economy.

Why portfolio was up 5% yesterday (2-23-09) alone and is up over 50% since the highs in 2007 so listen to the idot who is losing his ass because he trades on false hope or listen to the facts, it's your choice.

Feb 24 11:24 AM

[PainfullyAware:]

We have crossed over the breaking point of consumer debt. The base must reset. This will not be a short process. Since all the economies were in symbiosis durring the "Money Shell Game" of moving their leverage around they were susceptible when the consumers "Wheels Came Off". This was the event that "Destroyed The Foundation" that everything else was built upon.

Now the Shadow Banking System has so much exposure to instruments that are almost insurmountable in complexity and opacity that no one has any confidence in solvency - Therefore the tragedy we are currently in. Until this issue is dealt with there will be no recovery; the system will not return to normalcy.

Housing may have been the fuse that set this whole pile in motion of collapse, but it has now become a symptom of a much larger cycle, of interwoven reinforcing results, of insolvency suspicion within the financial institutions and framework of the economy.

Feb 24 11:27 AM

[henarl:]

The thing with the market is that most people are really not too concerned with how much money they will have in 30 years. Rather they are worried about how they will do this year - whether they will keep their job (if they still ave one), how they will pay their mortgage or be able to buy the other necessities of life. Thruout 2008 and so far in 2009, the economy and the market has not given them much to calm their fears and waiting for Obama's magic cure to kick in hasn't created all that much enthusiasm. The rich will be able to ride out this slump. It's the rest of the population that's in trouble.

Feb 24 12:11 PM

[James H. Wang:]

I agree with the comments here.

Better in 2009? Other than macro "feeling" not being a sound trading strategy, I don't agree with this logic at all.

Let's say we are "materially" better off in 2009. Pretend, anyway.
That still doesn't mean that the S&P500 is fairly valued or anything is even close to bottom.

Don't forget, 2008 might have been "materially worse" but it was also grossly overvalued with phantom toxic assets that we somehow pretended were golden. Thus, S&P500 and the market overall will still plummet, regardless of the material considerations.

I'm not predicting that we're going to fall a great deal or a little. I'm just pointing out that this statement really means little, even if true.

Feb 24 01:26 PM

[P. Kalven:]

Thank you for your perspective one and all.

I look forward to reading it all again tomorrow after tonight's speech.

Would that you are correct David, because those of us who are in trouble could use the relief of some stability returning to economy.

As for the pessimistic "I told you so's", could you please just go across the street and help the economy, buy something, coffee, hot dog; the vendor will thank you. Telling the Captain of the Titanic the ship is sinking is overstating the obvious; turn your anger and fear into something constructive and we might all fair a wee bit better.

The truth is the economy will have to rebuild from the bottom up, go buy something that creates demand in the supply chain.
.

Feb 24 02:32 PM

[doctordoctor:]

"The truth is the economy will have to rebuild from the bottom up, go buy something that creates demand in the supply chain"

you out to lunch? the "economy" is fine, its the contracting of markets, much like what was done with oil last springtime, that lead to the melt down. somewhere between 60 and 100 trillion dollars of lost contract values(depending on which pundit you read) that has done us in. otherwise, the global economy is fine considering the sudden lack of credit worldwide. supply and demand are fine, production is fine. its the credit markets that are not fine.

On Feb 24 02:32 PM P. K. wrote:

> Thank you for your perspective one and all.
>
> I look forward to reading it all again tomorrow after tonight's speech.
>
>
> Would that you are correct David, because those of us who are in
> trouble could use the relief of some stability returning to economy.
>
>
> As for the pessimistic "I told you so's", could you please just go
> across the street and help the economy, buy something, coffee, hot
> dog; the vendor will thank you. Telling the Captain of the Titanic
> the ship is sinking is overstating the obvious; turn your anger and
> fear into something constructive and we might all fair a wee bit
> better.
>
> The truth is the economy will have to rebuild from the bottom up,
> go buy something that creates demand in the supply chain.
> .

Feb 24 11:16 PM