Markets Have Hit a Bottom, But Is It THE Bottom?

The spring in the financial sector’s step last week has some wondering if bottoms are finally forming in for the equities market. This is based on an assumption that weak banks couldn’t get much cheaper and that, to Wall Street’s way of thinking, a “real” bull rally has to be led by financials. Certainly it's true there is much less $ (or £, or €) value that can be chopped off them than has already been. Early year profits indicated by some of the larger and weaker US banks, and comment by US Fed Chairman Bernanke that the recession could be over by year’s end if the banking sector stabilizes, also helped the cause.

Of course this enthusiasm does ignore that going from anywhere to 0 is a 100% loss so financials are not exactly risk free. Concern about whether some banks need to be nationalized in order to induce some true stability is not yet off the table. The detail of the early year profitability is yet to be laid out, and it came with cautions that Q1 still has a month to go. Banks’ operating profits can build through a quarter only to be lost on booking off capital requirements and write downs. Wall Street views too much that looks bad as a one time event that shouldn’t be included in “real” earnings. Losses are losses where we come from.

The big news of last week was Bernanke finally pulling the trigger and starting a program of quantitative easing, or money printing as they call it in the old country. Things have gotten to the point that Helicopter Ben will be second guessed on every move he makes. We think that you have to start with the assumption that the Fed has some data in hand that we mere peons are not privy to. Given that he made the decision after equity markets had already put in a substantial rally, this was not the Fed coming to Wall Street’s rescue. It was the Fed coming to the bond market’s rescue.

Yields on the 10 year Treasuries had been creeping inexorably upwards for over a month. As we have noted several times in the past few months, the Fed has to find ways to allow the Treasury to sell a mountain of paper without driving up interest rates at the worst possible time. Buying Treasuries will serve the dual purpose of pulling down rates and pumping money into the US economy. The announcement helped create the biggest one week loss for the US$ ever. As we note below, traders fear this makes an inflationary endgame all but assured when the economy really starts to recover.

After a 15% move, the major markets look ready to take a breather. We’d like to think we have seen the bottom in the markets but there is still a lot of bad news to get through. Earnings season starts in two weeks. No one expects good numbers. The real question is how much of the bad stuff is priced in. No one will know the answer to that question until we see how traders react but we are still holding to the belief that a bottom is likely to come during the summer doldrums. It may not be much lower than this month’s but another revisit of the lows seems the most likely course of events. We also can’t help but wonder if the Fed’s move means there is another shoe left to drop that the rest of us don’t know about yet. It’s hard to imagine there are any new sources of bad news left, but it hasn’t paid to make that assumption for two years.

Despite the improved credit markets we are still in a cash-driven market. China and other creditor economies are right to insist on seeing the rot dug out of the system before doing any more to help fix it. China already has a large cash infusion moving into its economy, and indicates it expects a loss on its plans to buy more US treasury paper. It has also made it clear it sees no reason to expand its spending plans, at this point. It, and others with functioning banking sectors, will increasingly refocus on workarounds to avoid western banking.

The issue that would be of most concern to us seems, right now, to be the least contentious. There appears to be agreement to avoid hampering global trade, at least overtly. Protectionist measures were one of the worst problems of the dirty 30s, and so far governments are shying away from them. Hopefully that continues. Markets will react badly if it doesn’t.

China’s government has been replenishing its stockpile of copper, which has helped reduce warehoused copper available through the LME by 10% in two weeks. The warehouse offerings have been reduced in part because copper users themselves are more willing to hold inventory. China’s buying helps, but so does an easing of credit conditions that makes cash generation less urgent. Since we are cautious about unfinished debt-crisis business in the financials sector, we also have to remain cautious about the strengthening copper price. Current LME copper warehouse stock levels are still 45% above the start of this year, and 300% of last year’s lows after all.

With a shift away from the greenback, we could well see more copper price gains regardless of changes to warehouse stocks. These would be real in so far as copper should reflect the inflationary pressures in the US that are inherent to a $ weakening. However, we would still like to see continued reductions to commercial stocking levels support any price gain for the red metal, rather than simply its return to the currency system. It’s worth noting that if China adds the amounts rumoured (700,000-1,000,000 tonnes) to its government stocks and leaves it there, this year’s expected copper surplus will disappear. The Chinese buyers are not fools. They were the ones selling $4.00 copper to hedge funds, after all. We think their statement of intent is real but that doesn’t mean they will either chase or drive the price higher.

Announcement of a move by the US Fed to buy the long end of its bond market also had the expected impact on the gold price. Having consolidated to the US$900 per ounce level, we think it likely it will now be a “currency of choice” in a move away from the US. Gold (and most other commodities) have gone back to their anti-dollar status. After moving with the Dollar since the start of the year, correlations have again reversed. There are many who place undue faith in the ability of the Fed to reverse the sort of trades it is about to start. It’s common for the Fed to undertake small scale refi activity and reverse it later. The difference this time is the operations will be several orders of magnitude larger. Even assuming the Fed wanted to reverse them (a big if at this point), it can’t do it in the midst of the Treasury’s funding campaign without blowing up interest rates.

A more important question is how other central banks will react to these moves. More of them may feel compelled to follow the US lead if only to help maintain competitiveness of local products. To the extent that commodities continue to be viewed as currency proxies that cannot be created out of thin air this should help metals and energy prices. It will however make price changes more unpredictable. While the situation is clearly bullish, don’t think that these latest Fed moves have made gold or anything else a straight one way trade. There is no reason to expect volatility to fade away any time soon.

Stock position: None.

Comments

[malach hamo...:]

tell me how many jobs will be lost in June-August; then we can talk bottoms.

Mar 25 08:07 AM

[robert99:]

My gut tells me this rally isn't over yet, and my mind tells me that there are too many people who believe that this is 'only a bear market rally,' and that it will fail at any time. Once there are enough people who believe that the worst is behind us and the markets have already bottomed, it will turn back down again.

Mar 25 08:33 AM

[Doug Poretz:]

Your article is excellent but it is based virtually entirely on looking at the economic/market crisis as solely an economic/market crisis -- I don't think it is. I think this is primarily a cultural problem of widespread irrationality from all quarters (governments, individuals, institutions and the investment/finance community as a whole). As such, cultural change will be one of the results -- among the cultural changes will be a much more conservative consumer, and that will be important because the consumer accounted for somewhere around 70% of our economy at the peak. In addition, it is becoming increasingly clear that the world is on the precipice of major political issues -- take a look around the world (see this narrated, self-running PowerPoint for details: tinyurl.com/daaua9) -- what will happen to markets worldwide if any of the massive protests erupt into something more than just "ordinary" protests? If you missed it (which wouldn't be difficult given the US mainstream media virtually totally ignoring it), 3 million people protested throughout France last week -- and look for major events at the G20 meeting coming up. The threat is very real and growing as the recession spreads. Then there are the issues of a globally interconnected financial market. And there is also the turbulence that comes from the transition from a manufacturing to a knowledge economy. And volatility not only in the price volatility but the access to basic commodities such as oil and food. So, the analysis of whether we are at a bottom that is based on economic and capital markets issues is enlightening but too shallow. Personally, I am not worried about whether the market is at a bottom of not at this moment -- I am much more worried about non-economic news that could blow away the entire cocept of a bottom.

Mar 25 08:38 AM

[AndrewBaker:]

We won't hit the bottom until the extent of the banks' bad assets is truly known, which is still information that has not yet come out. The recent rally in copper and other industrial metals was based on Chinese buying and in response to the market rally based on hype and hope not real data, and these base metals are once again dropping in price in line with the fundamentals, being weak demand and plenty of stock. Get ready for the next down-leg.

Mar 25 09:15 AM

[ain't no fo...:]

I wouldn't worry about what's gonna happen in 6 months. We have a bona fide rally going on here - take advantage of it.

This is a short term/traders market, and the trend right now is UP.

Mar 25 10:19 AM

[Did U Think...:]

There is a simple indicator as to whether we have hit "the bottom" and that is to look at the strongest of the strong to see if they have capitulated. One good stock to watch is IBM. Remember back during dot bomb? IBM held out until the very last but then in about a 6 month period it collapsed nearly 50%. So far IBM has been holding out with a meager 25% decline from what everyone must understand to be a credit induced blow off top. That is simply not a big enough decline to account for the biggest credit bust in the history of man. When IBM is down 60-80%, only then can one start realistically believing that a bottom is near. If this bust is as bad as 29-33 then the Dow was down nearly 90% from its peak. Why should it be any different this time? Contrary to what the talking heads are saying, the government of that time did in fact throw the kitchen sink at the deflation problem but it was just too big to "fix". The same will be true this time. Government cannot replace the economy with money printed out out of thin air.

Mar 25 12:56 PM

[ageczi:]

I agree that the market's recovery will be led by the financial sector. Toxic assets will disappear from the books of the nation's troubled banks following the Fed's efforts, making their balance sheets look healthy again. Shareholders' equity will increase virtually overnight which will begin a rally on the financial sector. With luck, QE will achieve its intended purpose of lowering interest rates on government borrowing so that taxpayers are stuck with a smaller bill, as well as aid in restoring the flow of credit to firms and monetizing both consumer and government debt (hopefully within reason). Facing the dual devils of deflation and inflation, I think the choice is obvious. Yes, there will be repercussions. Yes, they will be on the large scale. Yes, we will be paying the price, but we have been enjoying the benefits for years. Fundamentally, we have not hit macroeconomic contractionary rock bottom and we are far from it. Therefore, the market has not met its potential bottom either. Much like the unemployed and the bankrupted, the market's only savior is effective monetary and fiscal policy even if it is the perceived (or real) enemy.

Mar 25 02:50 PM

[traderstraffic:]

How many banks have gone down since the first of the year? How many banks have gone down in the last two weeks? And the market goes up? What is wrong with this picture? Sell all the stocks you have right now. We are looking at 5,000 within the month. You want to talk bottoms, just watch the bank failures, figure it out on your own. Maybe we are seeing market Manipulations for about a week. Banks go under the market goes down not up.

Mar 25 03:07 PM

[The A man:]

When firm's start reporting quarter after quarter of bad numbers and they continue to roll out with poor results; reality will sink in.

I really think Obama is doing all he can to lead us out of this and yes we will come out of it. Warren Buffet understands the strength of the US economy.

What we are all discussing is "are we there yet!" No....we're not there.....not yet.

Rally's have happened before. To call this the "Great Recession" and to watch the show illustrates the apparent. We obviously don't get it yet greed is with us. Tat the bottom is passed....let us pray it has! I think not.
The A Man

Mar 25 05:52 PM

[A.W.Bost:]

Mr. Doug Poretz,

My my sir you are absolutely right. I said in November that this downturn will and has completely and fundamentally changed people forever. What wall street and others have not realized yet is that the spotlight has now turned to them and their companies and now especially on our Government. Being born in 1987 our generation has been almost completely blind to everything that has gone on with everything. We spent A LOT of money on things we never needed and now we all now realize (with unemployment and our pocket books) how important we need to plan for our future and save every penny. We have all now become completely frugal which has begun and will continue to kill corporate profits. This downturn is completely different from others in the way internet affects our lives. The internet is THE X-FACTOR and gives us unlimited knowledge about everything. We are puppets no longer. There has been a rude awakening for us and now everything is planned for and bought with a purpose. This rally is hilarious because the BIG BANKRUPTCIES have yet to begin. There needs to be a humongous washout with the excess of everything, especially horrible companies that continue to plague us and dilute the resources that are left. WSJ front article "COMMERCIAL PROPERTY FACES CRISIS" shows a taste of what is to come. No one is spending anything at all anymore. THERE IS NO MORE MONEY and everything left will be for (essentials first, pay debt, save the rest, and then very calculated bigger items). This country went from one extreme to other and no one should underestimate the severity of this flip and how long it will last. I believe it will last for a long, long time because my generation is just starting to have their own families and we will do anything to save for our future kids and not be caught in this situation again when things really do matter. THIS WILL BE THE GREAT RECESSION #2, and Gov't is just exacerbating everything. I now hate my Government, and the biggest example is what they have and continue to do with GM and Chrysler. Our only ray of hope is when our beloved troops come back and reignite this very broken puzzle. THERE NEEDS TO BE A WASHOUT OF THE WASTE AND UNTIL THEN THE BOTTOM WONT BE MADE.
-Careful College Student

Mar 26 11:45 AM

[TaurusTrader:]

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Mar 26 12:21 PM

[wildcat42:]

I agree with some of the other commenters: "how can we predict a bottom, when we still don't know the extent of the damage?" This a short-term rally (3-6 months) at-best, because it's not market-driven. Show me one sector that is truly healthy enough to push the DOW up 500 points in one day. If you don't believe this rally is somehow tied to newly installed government policies, then you haven't been watching the news.

Our government is buying its own debt (Fed purchases bonds) through a tool the Japanese have made popular, calling it "quantitative easing". That is NOT a sign of a healthy market. What we've witnessed in the last couple months is the implementation of a long-term plan that will ultimately devastate the Dollar and artificially strengthen the stock market for a time. It won't last, unless the government plans on propping up the market indefinitely.

Is it possible that China is buying copper, simply because they're infrastructure is weak and the prices were cheap? Or, perhaps, it's related to the fact they're sitting on a lot of US dollars. If I was China, and just witnessed the US implementation of quantitative easing, AND was holding 100s of billions in US dollars...Why not hedge yourself against the inflation of the dollar with a commodity you know you're going to need? For that matter, commodities in general.

There's very few of us on this site that deep-down don't want this nightmare to be over. But, why would you believe the problem has been fixed in the last 5-6 months (referring to end-of-September 2008)? It took years to get to this point, and sadly, I think it's going to take many more years to get out of the mess. (You can destroy in seconds what takes years to build.)

Mar 26 01:53 PM

[Manbearpig:]

i completely concur. a) gov't is buying its own debt, b) gov't is supporting its own citizens' /companies' over-consumption that is keeping the country out of depression.

a) i would imagine that the gov't is privied to data that us commoners do not. then, how is it that if they think the economy is about to rebound in the 2nd half of the year, they feel the need to put trillions of dollars into the marketplace within the past month? b) without the programs we have in place (like unemployment checks being extended, etc.), I think that we would be in much more dire situation. For one year recessions, gov't can keep consumer spending up by providing these capital infusions; however, the longer the recession lasts, the harder it will be for countries to grow at above theoretical potential gdp growth rate in order to catch up to the unemployment slack it had built up. i predict lack in consumer spending due to actually saving their income and not rely on real estate asset price increases to mitigate
any real growth.

lastly, a lot of the rally has been based on further gov't policies. just common sensically, when have gov't policies worked efficiently and without many negative unintended consequences? the market is trying to price in best case scenario if all of these things are implemented perfectly. but based on aig, tarp, etc. actions, i'm betting against the u.s. gov't vis-a-vis what the market is pricing in. i have begun buying snp short at the close today. i'm going to pyramid short and start fading my positions approximately every 50 points rallies on the snp.



On Mar 26 01:53 PM wildcat42 wrote:

> I agree with some of the other commenters: "how can we predict a
> bottom, when we still don't know the extent of the damage?" This
> a short-term rally (3-6 months) at-best, because it's not market-driven.
> Show me one sector that is truly healthy enough to push the DOW up
> 500 points in one day. If you don't believe this rally is somehow
> tied to newly installed government policies, then you haven't been
> watching the news.
>
> Our government is buying its own debt (Fed purchases bonds) through
> a tool the Japanese have made popular, calling it "quantitative easing".
> That is NOT a sign of a healthy market. What we've witnessed in the
> last couple months is the implementation of a long-term plan that
> will ultimately devastate the Dollar and artificially strengthen
> the stock market for a time. It won't last, unless the government
> plans on propping up the market indefinitely.
>
> Is it possible that China is buying copper, simply because they're
> infrastructure is weak and the prices were cheap? Or, perhaps, it's
> related to the fact they're sitting on a lot of US dollars. If I
> was China, and just witnessed the US implementation of quantitative
> easing, AND was holding 100s of billions in US dollars...Why not
> hedge yourself against the inflation of the dollar with a commodity
> you know you're going to need? For that matter, commodities in general.
>
>
> There's very few of us on this site that deep-down don't want this
> nightmare to be over. But, why would you believe the problem has
> been fixed in the last 5-6 months (referring to end-of-September
> 2008)? It took years to get to this point, and sadly, I think it's
> going to take many more years to get out of the mess. (You can destroy
> in seconds what takes years to build.)

Mar 26 04:16 PM

[Between The...:]

Remember, all of Japan's Quantitative Easing did not result in inflation, destruction of the yen, civil unrest, or anything other than slowing of the inevitable fall. The Japanese stock market had many mini-rallies as the government tried every stimulus, monetization, and confidence-building policy in the playbook. However, it was mostly malinvestment in bridges to nowhere, and the debt bubble was slowly deflated, taking down the assets and stock market with it.

Make no mistake - if we continue the failed policies of Japan 1985-2000, we will suffer the same consequences.

Mar 26 05:42 PM

[Whitehawk:]

I agree with the comment on Japan: years on propping up banks and other weak companies, endless quant easing, high corporate taxes, and a whole host of negative policies on FDI/foreign investment. We would do well to look toward Korea to get an idea of an alternative. They are much more conservative in their monetary and fiscal policies.

In addition: there will be civil unrest in the U.S. We are not the Japanese. There is a growing negative sentiment to the continual thwarts to our constitution and business culture. This will meet with a flash point until the next election.

The Bottom: it will be retested.

In the Mean Time: Have a trader's mentality and look for arb opptys.

Mar 26 11:12 PM

[aarc:]

My target for SnP is still 600 to 630 range by Nov/Dec2009. We are still in a bear market rally until proven otherwise.

But I started loading up buying long-term holds on the way down closer to SnP 666 level specially financials since the BKX was able to form a 1-2-3-4-5 pattern to the downside while SnP was only doing a 1-2-3 down or an A-B-C down in Elliott Waves parlance. First high probability chance in more than 2 years to be able to do so with the financials.

It means that BKX has potentially reached the bottom while SnP was still in consolidation mode. Also BKX went down 8 months ahead of SnP and is expected to be the first in first out sector of the SnP.

This sell-off has never been so bad. It is the worst the whole world has ever experienced since the Great Depression. After the Great Depression, Dow Jones went up from $42 to $14,200. What a stretch! History repeats itself, or at least rhymes with the past, does'nt it?

Therefore, this is potentially the best buying opportunity the current generations of investors will ever had in their lifetimes. Who knows if it might take another 8 decades or so before the next opportunity presents itself. I will be long dead by then. Even if this proves to be worse than the Great Depression, starting to buy during sell-offs at these depressed levels is the next best thing to entering the market rather than finding the exact bottom. Try picking bottoms, it is extremely hard even by using Elliott Waves analysis which is the best technical tool there is in finding bottoms or tops for that matter.

What if we go to hell?

Then it does'nt matter whether I invest or not - I go to hell. I just don't want to feel sorry later not accepting a chance to go to heaven (metaphore).

Mar 27 06:56 AM

[twitee:]

We need to have our troop to come back home and fight the government that is destroying the fiber of the hard working American future that was built over the last two centuries.

The biggest enemy of this country and the world are the greedy Wall Street bankers (New York and London), and the Federal Reserve (a private company controlled by few American and European rich entities).

Apr 29 12:40 PM