April was apparently the best month since 3/00, with the S&P 500 rising 9.57% and the Russell 2000 up an astounding 15.46%. Despite the feel of a runaway freight train, the market wasn't able to get quite back to the station, falling just short of the 903.25 level at the end of 2008. One has to wonder if the bulls will treat a move into the green as a mulligan. While I don't think we will get that chance, I would argue that the 920 level will be extremely difficult to penetrate. I have been anticipating a peak of 860-920 to serve as the top of this bear market rally since discussing it on March 18th. In my opinion, the easy money in this rally has now been made, though if you look at the charts below (click to enlarge), you will see why I make that statement with great humility:
These two charts look at weekly rolling 3 month (top) and 6 month (bottom) price returns. We were pretty much off-the-charts oversold two months ago. As is typical, the snap-back from this condition inevitably happens, and it often overshoots. I find it interesting and not widely reported that the S&P 500 is now unchanged over the past 6 months. That means, of course, we have not only recovered from the March lows but the November lows as well (again).
Now, if you look at that top panel, you might say "Hey, we got another 20% or so to go!", but I would caution you to work through the math. When we look at this again in a month, we will be measuring against the price at the end of February. To give us an idea of what the data point will be, we can set a range based upon our current S&P 500 price of 872.81. If we decline 10%, remain unchanged or rise another 10%, the 3 month price return will be:
- -10%: +7%
- Unch: +19%
- +10%: +31%
More typically, the market would move +/-5% in a month suggesting that the most likely scenario is that the 3 month return will be between 13% and 25%. So, as long as the market doesn't absolutely tank, it seems as though we will see a typical level for a very strong 3-month return. Certainly the comparison will be very easy in the 1st week of June. If we retreat, as I expect, to say -8% from our current level as of June 6th, the 3-month return will be 18%. My point is that we don't have to keep rallying to get to traditionally peak 3-month moves. But, I am aware that while the 20% area is usually an extreme, we have seen a couple of 40% 3 month moves and of course an >80% back in the Great Depression.
When we look at the 80yr price chart (click to enlarge), again we must feel humble:
I shared a rather detailed forecast for this year, and things are playing out so far pretty much as I expected:
While the market certainly could fall as much as last year (37%) and might do so during the year, I will be surprised if it falls to that extent. Even if it does, the loss of wealth will be significantly lower given the smaller base now. We should get a rally at some point this year, though I expect it will come from extremely oversold levels. With that said, I don't expect any single quarter to come close to the carnage of Q4 but rather a more traditional death by 1000 cuts. My base case for stocks is that they decline about 15-20% this year (S&P 500 of about 720-765). This level should serve as a multiple of about 12X-13X S&P 500 earnings I expect now for 2010. I expect an interim low in late March to mid-April, a positive Q2, a low in late Q3/early Q4 (call it 625-675) and maybe a positive Q4 overall. I believe that the biggest story in stocks this year will be the large losses in some of the largest names, like General Electric (GE), AT&T (T), Wal-Mart (WMT), and the large banks. Unlike Q4, where stock-pickers had very little chance, I expect that we will at least have a shot this year despite the negative overall tone. 20-30% of stocks in the Russell 3000 could actually rise this year despite the overall pressure on the broad market.
I followed up this initial scenario a month later with some more support for my 625-650 year end low and noted:
The low at the low-end of the range I project for what will hopefully be "the" ultimate bottom would be a decline of about 31% y.t.d. in the Sep/Oct time-frame. While the market seems very oversold now, playing that game hasn't been a fun one except for very brief periods. While we could be setting up now, I think that the next big bounce comes in Q2 as we get to what will surely be yet another absolutely horrible earnings season. We are still early in the year. While fundamentals seem to be getting worse around the world, there is a ton of fear and a large wad of cash that is afraid still of missing the next big rally.
Clearly I underestimated how far the market would decline early in the year, though it bounced where I thought it might bounce ultimately in Q4. That bounce began slightly earlier than I originally forecast. At this point, I believe that we get a double bottom (or worse), which means rough times ahead (most likely beginning in the summer).
I have shared my views about why the economy will struggle for quite some time and discussed the improvement we need to see in certain key indicators (housing prices, savings rate and balance sheet restoration for financials and industrials) (the same piece discussing the market bottom). For those who think systemic problems that built up over one or two decades can be fixed so easily, I urge you to consider that what appeared to be "normal" was really somewhat of a mirage. As long as consumers have access to rationed capital at expensive prices, they will no longer consume like drunken sailors.
The key to success for investors this year will be an ability to shift lanes at the right time. Investing can be like picking a lane on the freeway. Sometimes you need to stay in the inside line, other times you need to switch. Sometimes you need to get off the freeway and do a u-turn - head toward the other direction. I have been telling my friends, clients and subscribers to my model portfolios that I am like the elderly person driving in the big Lincoln. Rather than stay on one of the inside lanes, I continue to get more conservative. You can check out my holdings to see what I mean. Well, I won't drive on the freeway at all. Instead, I am driving on the access road.
While I may have gotten too conservative too soon (as we entered the top of the range at 860 13 days ago), I have been overcoming my trepidation with some good security selection. My Top 20 Model Portfolio is now up 18% YTD. My Conservative Growth/Balanced Model Portfolio has increased 5.7%, which is about 6.7% ahead of its benchmark of 60% stocks and 40% bonds. Since our July launch, the model is down 0.4% compared to the blended index return of -15.9%.
This has been a truly remarkable rally, but it has all the characteristics of a bear market rally. The rally is 50 days old. The last rally lasted about 47 days (11/21-1/6). Of course the most recent rally has been much stronger. We are coming up against some very powerful resistance levels including the magic round 900, the year-end close of 903, lots of congestion 910-920 and the YTD high of 944 (which is out of my 860-920 range top). Most importantly, the "strength" in the economy is really an absence of deterioration. Credit spreads need to contract, companies need to issue stock, and we need to remember that the government has put training wheels all over the place.
Disclosure: No position in any stock mentioned.