No Time for Complacency: This is a Bear Market

This article is a follow-up to an article from two weeks ago that I wrote because I felt so strongly that we were due for a bounce. Well, while the bounce may not be 100% over, it is done for all intents and purposes. I am not suggesting that we are about to go into free-fall again (yet), but long investors shouldn’t feel as though that cash is burning a hole in their pocket. Further, those who missed punting vulnerable stocks now have a second chance to prune their portfolios of companies particularly susceptible to profit-margin erosion or lack of access to capital. I expect that the market will create an interim range that consolidates this move down since October before reaccelerating in the Spring and ultimately making lows this Fall (S&P 500 1170 area).

To be bullish here, I think that one would have to believe:

• Fed Funds cuts and fiscal stimulus will prove effective
• Analyst estimates are now reasonable
• Technical analysis is for the birds

The policy responses from our government have been highly inappropriate at best and potentially extremely dangerous. The Federal Reserve, in trying to help the banks by lowering FF, looks desperate and reactionary. It runs the risk of alienating our “outside investors”, devaluing our currency, raising inflation prospects and hurting our senior citizens who live off of their savings. The steepening of the yield curve is alarming. There is NO rate low enough to create a spread (between short-term borrowing costs and long-term lending or investing rates) to compensate lenders to borrowers that are impaired. Efforts need to be directed towards stabilizing the value and/or liquidity of all of the CDOs and other distressed securities that litter the balance sheets of our financial institutions. Some might argue that we will have a refi boom with the lower mortgage rates. Good luck to those who NEED to refinance, because your loan appraiser may want to see you kick in some equity (the “cash-in” refi). The fiscal stimulus package is barely a finger in the dike and smells of politics. Recipients may pay down some of their debt or build savings: It is very unlikely to do much more than cause a temporary blip in spending at best. Keep your eyes on the dollar/yen and dollar/euro relationships as well as the 10yr Treasury (absolute yield, relationship to short-term rates and to corporate bonds) to monitor the risks of these policies. The chart below shows the steepening yield-curve, widening credit spreads and deteriorating dollar value:

I discussed the disconnect between consensus estimates and reality three weeks ago. Not surprisingly, estimates have moved down, but this is just the beginning of a process. As I mentioned in that article as well as on several occasions in 2007, we are in the midst of a profit-margin squeeze. While the PE ratios look low historically, especially in the context of low (artificially low) Treasury rates, soft revenue growth combined with cost pressures will prove that the “E” part is just wrong. While I expect that we are in an official recession, this one is likely to be very different from many others due to its genesis. This isn’t the traditional inventory cycle but rather a severe fall off in demand due to a constriction of credit. Usually the housing market is a victim rather than a cause of an economic slowdown. I think that when the consensus for 2008 is closer to reasonable ($80), it will show that the market properly incorporates the current economic environment. It would be wishful thinking to expect that this process would be done so quickly. Then again, the sub-prime crisis will be contained!

Finally, the primary trend is now bearish until proven otherwise. All of the major markets domestically (and most globally) are in decline. The long-term moving averages have rolled over and are falling. The former leaders of the market and the safe havens due to their lack of domestic exposure (hah!) haven’t proven to offer much shelter from the storm. This bounce is only a bounce in my opinion. Volume hasn’t been particularly strong and no leadership has emerged. The greatest strength has come from the beaten-down Consumer Discretionary and Financial sectors, but they haven’t broken their downtrends. One of the technical tools that I use is Fibonacci analysis. If you aren’t familiar with this concept, I suggest that you learn more. I have found it to be extremely useful in terms of identifying entry and exit points. The major indices (as well as the Financial sector (XLF) and the Consumer Discretionary sector (XLY)) just cleared the 38.2% retracement on Friday. Of course, there are no guarantees that they couldn’t rally further (to the 50% or even the 61.8% level), but we are in the early stages of a bear market, so I would be surprised. Other things I look at such as the 50dma and volume-at-a-price all suggest very limited potential price improvement from here. I would expect that the S&P 500 struggles to get through 1410-1420 over the next few months, though it could rally as high as 1455 and still be a bear market. I envision the trading range to essentially be 1310-1390. It is implausible to think that such a big mess, rooted in our society’s desire for instant gratification, could be fixed so “instantly”. Sorry, this is going to take a long time to fix and will result in at least a 1yr bear market (hopefully just one year).

So, after a very brief stay in the bull camp, I am switching back to the team that I continue to think will win this year in a big way. While I am not sounding the alarm at this time, I have started to put on some of my favorite short ideas again and have moved my net exposure via cash and ETFs to slightly negative. I disclose a complete listing of my individual securities on my website. Note that I manage a long-only charitable foundation for my family, so there are many securities listed that I own because I have minimum equity investment requirements. I do continue to believe that Healthcare is the place to be this year – here are some of my ideas (and I would toss in ETF Biotech SPDR (XBI)). Good luck!

Disclosure: Long XBI mentioned in this article

Comments

[veeblefetzer]

Now more than ever, it is impossible to predict future price movements in the stock market. With millions of people being able to buy and sell instantly online and all of these people trying to outguess everyone else, attempting to figure out what will happen is futile. Technical analysis may appear to put some sort of scientific approach to work, but it's still an attempt to predict something which can't be predicted.