Was Last Week's 'Wilt' a Start of the Much Anticipated Correction?

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (June 22nd):

..."While history doesn’t necessarily repeat itself, it does sometimes rhyme.” We think it might just “rhyme” this summer as the equity markets trade sideways as investors contemplate whether the improving economic numbers are ephemeral or for real. Our guess is this won’t be figured out by the markets until the late summer.

Admittedly, it is difficult to envision a “V”-shaped recovery, even though the history of recessions is that the sharper the downturn the more vigorous the upturn. In the current instance, following the recent rally, stocks are now priced such that they need a solid economic expansion to extend their gains. The problem is that economic expansions are driven by rebounds in housing and autos, which causes companies to increase capital expenditures and actually hire some folks. Such outlays are pretty dependent on debt financing. Unfortunately, given the country’s debt deleveraging mindset, it is difficult to embrace the thought of a sharp economic recovery.

That said, I still believe the economic numbers are going to look better than most people think into year-end. That view is spurred by various governmental programs / incentives, as well as the HUGE amount of money being thrown at our problems. As UniCredit’s strategist stated in Friday’s Financial Times, “The phase of a reality check we had anticipated on the equity market is now underway. [However] We think an abrupt and lasting deterioration in the equity market environment for 2009 is improbable. Instead, the trend of the 12-month forward earnings estimates should stabilize or recover in the second half because of the improvement in economic indicators.”

So the question this week is, “Was last week’s ‘wilt’ the start of the anticipated correction?” Interestingly, while the “cap weighted” S&P 500 was only down 2.6% for the week, the “equal weighted” S&P 500 was down 4.1%. The implication is that the decline was broader than the much-watched indices suggest. In fact, of all the things we monitor only aluminum and natural gas (Henry Hub, spot month) rose on the week, by 0.06% and 11.51%, respectively.

As readers of these comments know, while we think crude is pretty extended in the short-term, we have become increasingly constructive on natural gas over the past number of weeks even though that goes against the opinion of our energy analysts. Coincidentally, our friend and Director of Research for Investment Management Associates, Inc., Vitaliy Katsenelson, sent me this email on Friday:

“Six reasons why natural gas is a better investment than oil:

• Reserves deplete faster than oil (in general).

• Oil / natural gas ratio: the price of oil divided by the price of natural gas is at an all-time high (or close). This ratio stands at 17 (historically it has been at about an 8 or so). Natural gas prices will go up, oil will decline, or both. Also, natural gas is not a good hedge against the declining dollar (it is for the most part a domestic commodity) and storage capacity is more limited, thus not as admired by speculators as oil. This explains in part why it lagged the spectacular performance of oil of late.

• At $4 natural gas, it is uneconomical to develop and look for new reserves.

• No OPEC competition, LNG (liquefied natural gas) imports are uneconomical at these prices.

• Politically more favorable than coal.

• After emission caps are implemented natural gas will become a cheaper alternative than politically and environmentally unfriendly coal.”

Obviously we agree. Favorably rated names from Raymond James’ research coverage include Apache (APA) and Occidental Petroleum (OXY).

The call for this week: To repeat the question du jour, “Was last week’s ‘wilt’ the start of the long anticipated correction?”...[W]e too are somewhat confused. Indeed, over the weekend George Soros said that the “worst of the global crisis is behind us.” Yet, this morning the World Bank is stating that the prospects for the global economy remain “unusually uncertain” and lowered its world growth assumption from -1.7% to -2.9%. Then there is an independent research organization that opined last month’s economic figures showed the strongest rebound in five years.

Typically, the first stage of a rally is driven by liquidity. Then markets tend to “rest” for a period of time until improvement in the economy / corporation becomes evident, sparking another rally. That’s why we have been embracing the stock market’s 2003 pattern, as well as why we think it’s a mistake to get too bearish. Nevertheless, since the March “lows” we have often repeated that we can find NO instance where after making a generational oversold reading the equity markets become vulnerable in less than three months. Regrettably, we are now more than three months from those “lows” and we remain cautious.

Comments

[Dave Wrixon:]

What we have actually had is a large correction in a bear market, which has largely been the consequence of the anticipated stimulus. The market is now looking beyond the stimulus. It is a bit like looking over a cloud filled canyon. You just cannot see the floor.

Jun 23 05:47 AM

[conceptwizard:]

The correction is just starting and will restest the lows. We have in fact been in a bear market according the the S&P 500 since 2000.

The stimulus pacake hopes to reclaim 600,000 jobs this summer according to Obama's speech, when we are losing 600,000 per month. Not what I would consider encouraging.

Once the banks start posting their losses for the second quarter, this will accelerate the decline.

Jun 23 07:54 AM

[nonidiomatic:]

You can read whatever tea leaves you like; truth is, we are in uncharted territory and nobody can offer a definitive argument either way.

Jun 23 08:11 AM

[David Van K...:]

If we have been in a bear market since 2000, what was 2003-2007? The S&P 500 went up more than 50% in 5 years. That's a bull market by almost anybody's reckoning.

I really wish people would define their time frames when using terms like "bull market" and "bear market." The only way we have been in a bear market since 2000 is if you are talking about "secular" markets, i.e., overall trends that last 10 years or more. Fine, that's a point of view, but specify that's what you're talking about. Otherwise, to call the period since 2000 a "bear market," and thus ignore the 5-year runup from 2003-2007, is to just add confusion to what you are talking about.

Jun 23 09:10 AM

[Alphameister:]

Excellent comments by nonidiomatic and David Van Knapp above. When someone predicts new lows for a cyclical move based on his conviction that a secular bear market is in place, his comments should be measured against the reality of a powerful 2003-2007 cyclical bull market that took place within that presumed secular bear. Should we assume these guys missed the March 2003 lows as well? That being said, I don't see nearly as much opportunity today as I saw six years earlier.

Jun 23 10:35 AM

[Alphameister:]

Mad Hedge Fund has it right IMO. Serious short-term warnings after an explosive upmove that begs for "correction," but little likelihood of an imminent crash to new lows.

Jun 23 10:40 AM

[one eye:]

Mad Hedge: I doubt wheter you know the difference between "Insider" trading and Secondary offerings.

Barron's offers a Chart of weekly Insider trading and lists Secondary offerings.

Secondary offerings have surged, BUT Insiders have NOT sold within those offerings OVER the Past Two Months. There was one anomaly, Selling by one Company's Insiders which overwhelmed the Buying. That Anomaly has been smoothed out over time.

Insider Buying Remains Bullish.

Jun 24 02:14 AM