Current Market Conditions and Future Returns

Amid Friday morning's sideways action, traders and investors* would be well-served to take a deep breath and evaluate market conditions. Not so much to guess what'll happen in the very short run, but to gain some perspective on the broader lay of the land.

Over the last few days, it has become almost cliché to note that sentiment-based measures of market anxiety have not spiked as they did at the last few intermediate bottoms in the equity markets (see the followning two charts of the CBOE's equity put-call ratio and the VIX, both through Thursday's close).

click to enlarge

Note that current measures of the put-call ratio, both the single-day numbers and the 21-day exponential moving average, remain well off their March peaks. Though the 21-day EMA is in the neighborhood of its August, November, and January tops, the daily readings themselves have seen only one spike up to 0.9, and none to 1.0 or higher. So the picture here is a bit muddled. Or, to be precise, more muddled than it is even in its least-muddled configurations.

There's a similar story in the VIX chart, with daily readings moving back into the 20s, but the 21-day EMA lingering well below the levels associated with market bottoms over the last year. And we haven't had any single-day readings above 24 since March. Here, too, we have a relatively muddled picture, one that does not scream market bottom. But we live in a (Bayesian) probabilistic world--not a deterministic one--so we'll keep updating our "priors" along with all of you.

Here's another miscellaneous thought prompted by yesterday's action. In Thursday's "Four at Four," MarketBeat editor David Gaffen quoted a money manager saying this: "We're very much in a declining market...People have to realize that the returns in the market, or expected returns, are going to be lower." The point here isn't to indict the guy who said this, but we think the opposite is closer to the truth. As asset prices decline, expected returns actually improve.

Now, it's certainly true that this is walking and talking like a declining market, and near-term returns could well be negative. We aren't making any particular claim about near-term market action. But, again in good Bayesian fashion, we now have new data in the model: lower prices for long-term assets. And lower current prices imply higher future returns. That doesn't do much to salve investors' short-term pain, but it's true nonetheless.Those of us who speak to the investing public should work to clarify these counter-intuitive subtleties, popular understanding of which would help rank-and-file investors make fewer big mistakes.

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* Now that we mention it, this distinction could make a good addition to "Things We Don't Like About CNBC." Too frequently to count, CNBC's talking heads talk about what "investors" might want to do in the next few hours. At the risk of being a little picky, investors aren't especially concerned about what happens in the next few hours. In fact, they'll be better off if they totally ignore what happens in the next few hours.

Comments

[worthy:]

AMEN! At least regarding CNBC. Their thinking is far too short term oriented. They also have the bad habit of cutting off the remarks of the best guests, while the least accurate are allowed to drone on.

2008 Jun 29 08:38 AM

[you_can_cal...:]

As a member of the financial news guild, shouldn't you be screaming hysterically about something? This "rational approach" thing is going to get you into real trouble.

Careful you don't lose your union card.

2008 Jun 29 08:39 AM

[Reinko:]

The article has no quantification whatsoever, so it might very well be that stock prices are declining but P/E ratio's are still too high.

Don't forget that only a few weeks ago we had all kinds of weird people stating that 'the worst of the credit crisis is over' and talk like that. Therefore it could very well be that future earnings expectations are still far too optimistic....

2008 Jun 29 08:50 AM

[ajhough:]

This is time when one should take the TV shows with more than a grain of salt and take a deep breath. I have continue to invest in good companies, adding to positions and am behind a good deal in short term returns. Good companies with a growing dividend will prove to be winners eventually, but eventually may be a long, long time..

2008 Jun 29 09:37 AM

[icandoitdon:]

i love the "things we don't like about CNBC" page. dennis kneale is an absolute moron. kudos to sue herrara for coming as close to calling him that as anyone could come...wish i had seen it.

turn to bloomberg network. they take the time to talk to guests and don't constanty sugar coat and look for drama where there is none.

2008 Jun 29 02:42 PM

[GerryB43:]

The quality of television commentary on CNBC is uniformly low (at least until 7pm EDT on Kudlow). The blarney gene seems the only requisite for most slots.
Let's review: Investors always price increased perceived risk by increasing expected returns (translation: lower prices). They also create lower expected returns by piling into stocks in anticipation or even reaction to good news (translation: good news means lower future risk).

BTW Bloomberg has its low moments as well.

2008 Jun 29 03:57 PM

[SageNot:]

Dennis Kneale once worked at Forbes, & now CNBC gave him more $$ to work for them, who's the dummy here? (Not Forbes I dare say.)

Kudlow & Cramer are also "way over the top" with their frequent rants about talking their books! I've learned to turn my volume down when these 3 jerks are about, no wonder GE is thinking of dumping CNBC!

2008 Jun 29 04:03 PM

[Kunst:]

ArtfulDodger, you are getting boring.

2008 Jun 29 07:21 PM

[climbera5:]

Amen to that, seems like every opportunity for a political rant is rarely missed. I'll tell ArtfulDodger what I told Dennis Kneale, thanks but 'zip it'.

2008 Jun 29 08:06 PM

[jimdew:]

ArtfullDodger, I agree with you. This nation is doomed for failure if we keep the political people we now have leading our congress. They seem to be so self-serving - both sides, like a bunch of crooks. Seams like we don't have any statesmen in government anymore. I'm depressed at the age of 78 and kind of happy that I'm in the last enning of my life. Democracy, I believe, is doomed for failure.

2008 Jun 29 09:49 PM

[icandoitdon:]

hey, jim, it ain't over till it's over...keep your chin up and enjoy the ride as long as it lasts!

2008 Jun 30 01:02 AM

[Don't get n...:]

"Those who do not study history, are condemed to repeat it" John Thorn.

Been there-done that. .
Yadda yadda yadda. . . Try this quiz and see if you can pass it now. . . . . (PS. The quiz is at the end)

killeenroos.com/1/Rome...

2008 Jun 30 08:53 AM

[Don't get n...:]

"Those who do not study history, are condemned to repeat it" John Thorn

Been there- done that.

Yadda. . Yadda. . Yadda

See if you can pass the quiz on current status at:

killeenroos.com/1/Rome...
(Ps the quiz is at the end of the article)

2008 Jun 30 08:55 AM