Still Too Early to Celebrate Dow and S&P 500 Rise

Last week, the Dow Jones Industrials and the S&P 500 both gained 1.4%. Both indices are well above their January lows and appear to be heading higher. Have the markets put in a bottom (as Jim Cramer happily exclaimed back in late January) and are now merrily on their way up? It is too early to celebrate just yet.

The Federal Reserve rate cut on 22 January, in response to the global market stumble of the previous day, followed by another cut at its regular meeting, has certainly cheered the bulls and led many to mark that day as a market bottom. The Fed, certainly, has given indication that it is ready to intervene and provide liquidity to bolster the markets. At the same time, many seem convinced that the latest wave of write-downs has accounted for all the bad news associated with the subprime meltdown and the credit crunch. It may be a little too early for that, too.

What we are currently experiencing is another bear market rally; financials, consumer discretionaries, and other sectors will likely continue to suffer in the coming months. Due to travels in Asia during these past several weeks, I have not been active in the markets -- this has provided me with an interlude during which to step back from the daily torrent of market news and its associated wild gyrations. As I return, I see little that leads me to believe that we have turned a corner...

It is, perhaps, stylish to be bullish. Over the past several years, the investing public has been conditioned to "buy the dips" as the market continued to rise. Based on the financial news, one would guess that the average investor is bearish. However, it is not so; Barron's quotes David Kostin, a strategist at Goldman Sachs: "Contrary to popular belief, short interest is low and decreasing, not high and rising." The put-call ratio, a contrary sentiment indicator, provides a bullish signal the more put trading exceeds call trading; for the S&P 100 index, the ratio for the week ending 8 February was 0.65, the lowest in many months. Memories are short. Buying the dips is somewhat counter-productive when markets continue to decline.

Certainly, many sectors -- most notably the financials -- have already suffered significant declines and are in bear market territory. So now they must come up, right?

Perhaps being bearish is the true contrary position?

Why do I remain pessimistic? The subprime crisis and the resultant credit crunch are far from over; the worst should actually come this year. RealtyTrac calculates that 1.8 million mortgages are scheduled to reset in 2008 and 2009. At the same time, despite write-downs, companies have been notoriously slow to accept the full extent of losses associated with these developments and other aspects of the credit crunch. Far from being over, the bad news continues -- witness UBS' report of a $13.7 billion write-down this past week. Philip Finch, a UBS analyst, estimates that global banks face $203 billion in further write-downs. With billions of dollars of potential losses still unrealized, the true value of assets on the books of financial institutions remains open to question.

Beyond the financial sector, though many P/E ratios currently seem attractive, much of that depends on the denominator. If earnings disappoint, apparently cheap stocks will become much less so. At the same time, consumer confidence continues to ebb as the US domestic economy slows. Whether we enter a recession or not, domestic growth and corporate profits will slow.

As a result, I remain broadly bearish on the domestic stock market and especially suspicious of the financials.

Where should one look for profits now? Commodities, such as grains and gold, offer opportunities for further appreciation, as do their related stocks. Agnico Eagle Mines (AEM) interests me, though I have yet to purchase any shares. Energy exploration also offers opportunities for long-term appreciation.

At the same time, I continue to maintain my long-term core holdings and to build my "wish list" for beyond this bear market. Some financials have been unfairly punished and will undoubtedly prove good investments; though I think this punishment may yet continue for several months, I am waiting for the opportunity to purchase American International Group (AIG) and additional shares of Lehman Brothers (LEH), as well as some regional banks. Railways, such as Burlington Northern Santa Fe (BNI), are also interesting.

In time, the markets will turn. I cannot predict with any accuracy when that time will come, but I feel it is still too early to begin shopping now. I do not expect to call the bottom, but I am not in a hurry to catch any falling knives, either.

Comments

[steven West:]

nice analysis... I happen to disagree. Its stylish to be bearish right now.. so much so that the media has talked us into the recession that never was.
I believe the worst is now behind us but good luck to you

2008 Feb 20 10:30 PM

[Dana Cole:]

I'm skeptical of short interest figures, since after the suspension of the uptick rule, it must be incredibly easy for quant traders to do short day trades, that is, to naked sell something that's going down at the open and then pick it up again for less at the end of the day. Would such short trades show up in the short interest figures?
I don't know, and I'm not sufficiently interested to do the research. Even if they were recorded, however, with approximately 25 steep down days (by range) since the all-time high in the S&P, that kind of short trading would have generated a lot of cash by now.
On the other hand, with each 5% move down in the indexes shorting becomes more risky. Why? Because the "smart" (read "big") money is going to jump in at the best prices, which will bring about the mother of all short squeezes.
Many good stocks are now approaching their 10-year lows and are attractive for their dividends alone, some of which are offering higher yields than almost any other investment. Smart institutional traders are not going to miss the opportunity to get into high yielding stocks at low prices, are they? They've got to put their money somewhere. What else are they going to do with it?
Gold is great as a hedge, but where are the dividends? Commodities have got to go up or you're not making money.
I hope that you're wrong in your estimation of where we're headed, although the prospect of buying stocks at even lower prices is certainly appealing.
Thanks for listening.

2008 Feb 20 11:53 PM

[NoFate:]

Aidis - Truer words were never spoke. There is no indication of a bottom. Have we broken the trend line or has the 50DMA broken above the 200DMA ...not even close. There is not even a higher low. Why are people in such a hurry to throw their money away??

steven and Dana - SOLD TO YOU!

2008 Feb 22 02:27 AM