How Low Can This Market Go? The 40 Percent Solution 17 comments
- Roger Nusbaum's articles on Seeking Alpha
- Email Roger
- Follow Me on Twitter Roger's blog: Roger's wealth management firm:
-
Font Size:
-
Print
- TweetThis
Long time reader JackS left a comment noting that the average bear market decline is 34.1% (I thought it was closer to 30%) but that because the financial sector is at the heart of this bear market it could mean a 40% decline before we are done.
There are people who share JackS' concern with regard to magnitude. I have not yet moved off of my normal bear idea yet, I can see where it might fall apart but for now I continue to believe it will be within the range of normal.
As I read the comment I started to think about the sector weightings of the S&P 500 which are as follows, according to the iShares page for its S&P 500 fund which trades under ticker IVV.
- Tech 16.37%
- Energy 15.18%
- Financials 14.07%
- Healthcare 12.51%
- Staples 11.30%
- Industrials 11.19%
- Discretionary 8.11%
- Utilities 4.08%
- Materials 3.72%
- Telecom 3.26%
A 40% decline from the top, 1565, would take the S&P 500 down to 939.
In the decline thus far, financials have gone from 21% or so down to 14%. How much further can the sector fall? Since the market's peak in October, so not the sector's peak, the financials as measured by Financial Sector SPDR (XLF) is down 45%. So a 45% decline has worked out to a 1/3 less weighting in the index.
Again, how much further can it realistically fall? Don't confuse my asking the question with a belief that a bottom is in, but what is a reasonable expectation? If XLF were to fall by another 1/3 from here (which I think is more than will actually happen) that might work out to another 5% that comes out of the S&P 500, using simple math.
Both tech, measured by client holding iShares Technology (IYW), and industrials, as measured by Industrial Sector SPDR (XLI), are down the same, 20%, as the S&P 500 since last October but their weightings have inched up some, tech moreso than industrials, because of the massive underperformance of the financials.
IYW topped out at the beginning of the decade near $136 versus $52 today. How much further can it fall? Based on how this bear market has shaken out, is it likely that it could start to fall much more than the rate of the market? Again the tech decline has been in lockstep so something would need to change for tech to start falling faster.
Despite General Electric (GE)'s having fallen from $42 down to $27-ish, it still makes up16% of XLI so it has contributed a disproportionately large portion to the 20% decline of the sector. How likely is it the another 34% comes out of GE? If anything, the rest of the sector might catch up to GE.
What about energy? Not surprisingly, its weight has grown over the years and the notion that energy could correct is gaining some traction. I would not argue that the price appreciation has overstated how quickly supply and demand for oil is changing, but energy cutting in half relative to the S&P 500 after peaking out at only a 16 or 17% weight would be very odd.
Staples should do well in a bear environment and they have done well so I'm not too worried about them taking down the market. Healthcare, while it has not done as well as you'd think, is doing better than the broad market and a catalyst for more declines emanating from here also seems unlikely. The smaller sectors could implode inward like a supernova without doing a lot of broad market damage.
The point here is not that the market has bottomed or that 40% can't happen, but going sector by sector a lot of things would have to come together to create quite a storm for the decline thus far to only be the halfway mark.
A lot of things are down a lot and here we are down 20% for the broad market. A second decline of 40% or more within the same decade seems like a huge obstacle. It did happen during the 1930s. The high for the Dow was 381 in 1929. A low was put in in 1932 at 59. The ensuing rally topped out in 1937 at 194. The market then bottomed out again at 92 in 1942.
So is this decade really as bad as the depression followed by World War II?
Related Articles
|
Find People on SA
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largest
increase in followers
in the last 7 days-
1
David Fry
-
2
Bill Gross
-
3
Philip Davis
-
4
Tyler Durden
-
5
TraderMark
Fastest Climbers » -
1
-
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 17 comments:
If so....
----------------------...
The Dow hitting 40,000 by the end of the decade
The Nasdaq advancing at least ten times from its October 2001 lows to around 13,500, and potentially as high as 20,000 by 2009
Another strong advance in stocks in 2005, with a significant correction into around September/October 2006
The Great Boom resurging into its final and strongest stage in 2007, and even more fully in 2008, lasting until late 2009 to early 2010
But it has a large thing to do with the USA understanding what this 'credit crisis' actually is. Right now the US economy is tanking something like 20 to 30% of the GDP size in new debt.
The US economy uses this 20 to 30% of more debt to create a lousy 1% of GDP growth. This is a horrible debt to GDP growth leverage but the Americans are unaware of this.
Yet in some parts wisdom can be found, look at the next Federal Reserve G19 release about consumer credit, scroll down to where you see the auto loans rows.
You observe a miracle: Total car debt is declining... Link:
www.federalreserve.gov.../
In order to ensure you folks will not view me as another one yard wide idiot spelling his hobby's out, you can check my 20 to 30% of GDP needed for just 1% GDP growth at my favorite file, the Federal Reserve Z1 release detail, link:
www.federalreserve.gov...
Add up the relevant columns and observe that in the USA debt always grows much faster compared to the gross domestic product.
Litttle problem: The debt needs to be paid for and this goes via the gross domestic product.....
It looks like this system of more and more debt and always growing faster than the GDP is what in fact is the real credit crisis. Most folks think it is only some sub prime thingeling.
You may also notice that DJI stayed just about 1,000 for about 16 years between 1966 and 1982. You will also see a big run up of DJI in the 20 some years before 1966. Now, look at the big run up of DJI between 1982 and 1999. It is up to you to guess what is going to happen in the next decade or so. DJI hovering around 10,000? You may or may not believe in the law of average. But, no one can tell.
But you left out one very obvious possibility. It doesn't have to come from any one stock or any one sector. Isn't possible that they could ALL drop by 20% more or less to take the averages down?
On the one hand crude has clearly gone parabolic. On the other hand other commodities like Frozen Concentrated Orange Juice is trading at a similar price to 1980 in nominal terms, that is without adjusting for inflation.
I guess I will hold for now, or maybe accumulate a little more precious metals and OJ.
I used estimates for next week's reports and the charts clearly indicate that 1995 was a walk in the park compared to current conditions.
See
wrahal.blogspot.com/20...
Re housing, people have to live somewhere, so rents are going up. When rents exceed the cost of mortgage payments, housing will go back up.
Also, the world economy is all interconnected and, overall, is growing. When we are paying $150 a barrel for oil, someone is getting $150 a barrel for oil. So buy stocks in the middle east or Brazil.
We in the US have had it good for quite a while. It's time for us to get a much broader world outlook. Much of the "third world" is just starting to prosper and if we get some decent political leadership, that will be good for us, too.
In a message dated 7/11/2008 5:01:57 PM Eastern Daylight Time, billluemarble.net writes:
"At this year’s Money Show San Francisco, you will have the opportunity to meet face-to-face with top advisors and geopolitical experts. You will learn how they are evaluating the current markets and trends as we will be in the midst of an important decision-making period for all investors. Summer is typically a quiet time for Wall Street, but hopes are high for a rebound that will carry us into a 2009 bull market, which we had become used to in the last five years. Some of the investors who have been lulled by those good times are now stuck playing catch-up and can’t miss the next profit opportunity."
Sorry, this money show would be a waste of time in my judgment. I think we are bordering on a major depression, just as I said in an e-mail below, dated September 10, 2007. Because the banks have lost so much capital and the FED has warehoused so much securitized investments in a free exchange with the investment banks for treasuries, there is little money to fund Freddy or Fannie or Sallie or for regional banks to loan to even the best borrowers of residential/commercial real estate. Today we learned of default of IndyMac the second largest default in history of our country, (a supervised bank) as well as the possible default of both Fred and fan. Without capital, there is no way for the economy to expand. To think there will be a resume of the bull in 2009 is whistling in the wind trying to put pretty lipstick on a hog ready to be slaughtered, in IMO. The FED and Treasury are all pumping the market full of hot air to try to jawbone the investment community to have positive feelings when they know the opposite is true.
Senator Charles Schummer of NY told the truth about IndyMac a couple of weeks ago and depositors withdrew $1.3 billion leading to the collapse. Same if the Fed or Treasury told the truth. That is why Paulson lied about Freddie and Fannie, to be followed the next day by a story in the NY Times indicating a possible take over. Many lies to deal with. In my judgment, you should protect yourself so that you will have some fresh powder when the time is right. Either be in CDs with $100,000 insurance or short in my judgment. There are a few stocks that will do well in a major downturn, such as Walmart and Kroger, but I would watch POT close as the PE is really high. In a deep recession, prices of food could fall, people eat less and farmers less willing to buy expensive potash.
The market is due for a prolonged decline that will last longer than the 2000-2003 tech bubble bust since it was limited because we did not take the rest of the world down with us. This time, it has expanded world wide, and there is no area of the world that has the strength to pull the US out of the recession... Look at China and India stocks in the charts below. Not for several years. Look how long the 70's stagflation lasted, ending in the mid 1980's. This is much worse and is based on so much leverage in so many foolish investments. When you can borrow 1 and leverage it to $30-$40 as the investment banks did there has to be consequences. The securitized mortgage market is completely dead, no one trust these banks now. This means that the major source of revenue for C, Merrill, Lehman and others is doomed. If they have to stick to brokerage from the people who are still using brokerage firms rather than the Internet such as Scottrade, they can't make much money. They cannot compete with $7/ trade when they are accustomed to getting fees of 1-3% of the value of the trade. And, since they cannot use leveraged securities to do LBO, most of that business is in the tank. Clear Channel is an illustration of what happens when the banks can no longer afford to do the deal.
Take a look at the Dow, Max time period in Yahoo.
Note that the Dow was flat from the mid 1960's until 1983. Worse than being flat is a dip like in 2000 of the Nasdaq shows which parallels that of 1929 in terms of duration and depth.
**********************...
Subject: Danger: Steep drop ahead
Date: 9/10/2007 12:03:50 AM Eastern Daylight Time
Dear Friends and Family:
As for me, I see the same danger as this article. I'm short with about 1/2 in Jan 08 and the balance in Jan 09 puts. I plan to buy more Jan 09 soon and maybe Jan 2010 puts as this thing could get really ugly for a long time with a likely global recession when China can no longer maintain sales volumes to the US and their companies fold. Then companies all over the world will face hard times. In the past the normal cycles of world markets/economies did not coincide ... but they do today. Now when we sneeze, China may vomit like Japan did in 1980 when their Nikkei (^n225) peaked at 40,000 and have struggled ever since to recover to 20,000. Today it is below 16,000 and the trend is down for the last 12 months. In the 1980's Japan was flaunting their stuff to the world, just as most of the Pacific rim markets are doing today. Should those markets all drop to a fraction of their current price, wiping out a huge portion of the worlds investment capital and destroying unknowing investors in the Asian markets that have never experienced a bubble before, who in the world will help them recover their lost capital and how long would that take? Our economy is based on services that we sell to each other rather than manufacturing that we can sell in the world markets, so fundamentally we are weaker than ever before in history to recover from a major crisis.
I am extremely concerned about the false security we have in our real estate market. I left the appraisal business in 1993 and since then, appraisal standards have dropped, replaced with license laws bringing new appraisers into the residential market in record numbers, all trying to hit the number that will make the mortgage company happy so they will get future appraisal fees. Some national mortgage brokers only required a computer model appraisal and a simple drive-by appraisal. Many lenders made 100% to 125% loans to get upfront fees (like the S&L's did in the 1980's) to individuals without merit, agreeing to pay what ever they needed to pay to buy the house, looking for appreciation in the market to make the deal profitable, and expecting their income increasing enough to carry higher payments if interest rates were to increase. This same condition exist in China of all places! I have read that they are having about 20% housing inflation, which makes their 10-20% downpayment comparable to a 100% loan in the eyes of their borrowers who pay relatively low interest rates.
Now, the reverse is true of the low standards period. Higher appraisal quality standards will be required of appraisers. There will be no comparable sales to justify ever increasing house values. Instead the few comparable sales appraisers find will be sharply discounted, and point to lower prices rather than higher prices, and this is all they can use to support their appraised value. Coupled with higher credit qualification requirements, there will be few buyers who will want to step into the muck thinking better to wait instead and let the dust settle and their job secure before buying their first home or a different house and then only at a bargain price. Many first time buyers will be shut out of the market for some time to come. So then factor in the declining job market as new construction of all types slows for some time. It will take many interest rate cuts by the FED to reverse this cycle and more importantly...time to work through the mess. It is amazing to see so many pundants on Wall Street take the position that a single 1/2 point cut in the feds loan rate will make a significant difference while disregarding the underlying problems in the economy. At the same time, they also seem to see the future expecting more cuts before year end, which would only be needed if the market continues to drop along with sales and jobs! All of them are afraid to tell us the really bad news that would seen as a self-fulfilling prophesy. When I express my concerns, I will not move markets.
So, these huge piles of loans were bundled together, some are good, but many are not. No one has any way of reappraising homes that provide the security for the loans or to improve the credit of a weak borrower that is over extended. Now there is no market for these loans and banks and other holders are being asked for more security to back up their continuing operations. When they can't raise more, they take bankruptcy. There are many thousands of jobs lost in the lending industry which must be in place to help the mortgage market function when the market does turn. Countrywide Financial will fire 10,000 to 15,000 mortgage brokers and they were just propped up with a $2B loan from BOA. They make 1/7 of all residential loans. Who will fill their shoes when the economy turns?
I do not claim to know everything and I could be wrong and we should all pray that I am wrong, But, I have been a student of the market for many years and there has never been a situation like this before in world history. So, all I am saying is be careful and if in doubt about puts and shorts, go to secure money market funds and CD's. The biggest drop could begin any day now. Some of you will recall that this was the same warning I gave in November 2006. If I am wrong, shoot me, if I am right, then our country is in big trouble and I consider it my duty to share my concerns so that you will be prepared. I wish you well, what ever you decide to do.
John
**********************...
Danger: Steep drop ahead
Even if the credit crunch passes without a major catastrophe, the prices of stocks, bonds and real estate have a long way to fall.
By Jeremy Grantham, Fortune
September 5 2007: 9:27 AM EDT
(Fortune Magazine) -- Credit crises have always been painful and unpredictable. The current one is particularly hair-raising because it's occurring amid the first truly global bubble in asset pricing. It is also accompanied by a plethora of new and ingenious financial instruments. These are designed overtly to spread risk around and to sell fee-bearing products that are in great demand. Inadvertently (to be generous), they have been constructed to hide risk and confuse buyers.
How this credit crisis works out and what price we end up paying has to be largely unknowable, depending as it does on hundreds of interlocking and often novel factors and how they in turn affect animal spirits. In the end it is, of course, the management of animal spirits that makes and breaks credit crises.
Grantham: Home prices are well above the normal four times family income and will have to come down.
More from FORTUNE
The many faces of Ralph Lauren
Managing Marc Jacobs
Wowed by China's Net (but not the sushi)
FORTUNE 500
Current Issue
Subscribe to Fortune
But even if this crisis is contained, we are facing some near certainties that should be understood.
First, house prices may move on euphoria in the short term, but long term they depend on family income - the ability to pay mortgages and rent. At levels well above the normal four times family income, the market gradually loses first-time buyers until prices break and fall back to affordable levels.
House prices are in genuine bubble territory in the U.S., Britain and many other markets. In Britain and in some critical large cities in the U.S., for example, the multiple of family income has risen to over six times from below four times, and in London last year the percentage of first-time buyers was the lowest since records began.
From these high levels, prices are guaranteed to fall. In doing so, they will reduce consumer borrowing and spending power. They will also increase mortgage defaults, most of which lie ahead, and lower financial profits and confidence.
Second, profit margins are at record levels around the world. They have lifted stock prices directly alongside the rising earnings. They have served to raise P/E multiples as well, for surprisingly, investors on average reward higher margins with higher P/Es. This is fine for an individual stock, but for the entire market, multiplying boom-time profits by high P/Es is horrific double counting and sends markets far too high in good times (and far too low in bad times).
Higher margins also indirectly raise prices by providing more cash flow for buybacks and takeovers. So high profit margins offer multiple supports for the market, but they will certainly decline. They are the most dependably mean-reverting series in finance: If high margins do not attract greater competition, then a wheel has fallen off the capitalist machine. For U.S. and developed foreign markets, fair value (defined as normal P/E times normal profit margins) is about one-third below today's level, and for emerging markets it is about 25 percent lower.
Third, and most important, risk will be repriced. Last year a broad base of risk measures - including volatility (VIX), junk and emerging debt spreads, CD rates, high-quality vs. low-quality stock values - reflected the lowest risk premiums in history. On some data, indeed, investors actually appeared to be paying for the privilege of taking risk.
For fixed income, some spreads widened slowly at first this year and then unexpectedly widened rapidly in recent weeks. For equities, though, the process has hardly started. Junkier stocks continued to outperform into June, even as the subprime woes spread. At the end of the cycle, high-quality blue chips will once again sell at normal premiums or better.
Investment bubbles and high animal spirits do not materialize out of thin air. They need extremely favorable economic fundamentals together with free and easy, cheap credit, and they need it for at least two or three years. Importantly, they also need serial pleasant surprises in such critical variables as global GNP growth. All of this has been provided.
These conditions always produce excess and are always extrapolated. Unfortunately, like almost all other investment factors, they eventually move back to normal.
As wonderfully favorable factors cool off, asset prices will be under broad pressure, and risky assets will be under extreme pressure. If the credit crisis gets out of control, this will happen quickly and painfully. The important point to make here is that even if all works out well on the credit front, it will still happen slowly.
Dollar hits 15-year low
Fri Sep 7, 2007 6:29PM EDT
Email | Print | Digg | Reprints | Single Page | Recommend (1)
[-] Text [+]
1 of 1Full Size
Market News
Oil up as tight U.S. supply counters economic woes
Countrywide rises after job cut news
Kforce shares fall after jobs report
More Business & Investing News...
Featured Broker sponsored link
Free $50,000 Practice Account.
By Vivianne Rodrigues
NEW YORK (Reuters) - The dollar slid to a 15-year low against major currencies on Friday as data showed U.S. payrolls fell last month for the first time in four years, raising recession fears and pressure for the Federal Reserve to cut interest rates.
Traders dumped the dollar after the government said the U.S economy shed 4,000 net jobs last month, the first contraction in employment since August 2003. It also revised downward estimated job gains for June and July.
The payrolls data followed a larger-than-expected decline in July pending home sales reported earlier this week -- more evidence that a credit crunch that began with losses on bonds tied to risky U.S. mortgages was starting to put the brakes on growth.
"The jobs data is simply horrific and fans the most pessimistic fears," said Marc Chandler, chief global currency strategist with Brown Brothers Harriman in New York. "The housing market woes will undermine the U.S. consumer, push the U.S. economy into recession and drag down growth in much of the rest of the world."
Traders have been increasing their bets that the Fed will cut its 5.25 percent benchmark interest rate by a half percentage point when it meets on September 18.
"The Fed cannot keep ignoring the fact that the subprime and credit crisis has indeed hit the real economy," said Kathy Lien, senior currency strategist at DailyFX.com in New York.
"Americans are feeling the pain, and this will translate into weak consumer spending, which will drive speculation for a possible recession," she said.
The dollar index (.DXY: Quote, Profile, Research), which measures the greenback against a basket of major currencies, tumbled to a 15-year low.
The low-yielding yen was the biggest beneficiary, at one point rising almost 2 percent as investors fled risky trades funded by borrowing the Japanese currency at low interest rates. The dollar last traded at 113.48 yen.
"The entire foreign exchange market is going long yen and selling high-yielding currencies," said Matthew Strauss, a senior currency strategist at RBC Capital in Toronto.
The euro was up 0.5 percent at $1.3767.
Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut, called the payroll report "one of the bigger real surprises we have had for some time, and (it) can only add significantly to building negative dollar sentiment."
In August, when rising defaults on subprime home loans, made to borrowers with poor credit, began causing market turmoil, the dollar initially benefited from safe-haven flows as investors fled risk for U.S. Treasuries and Americans repatriated funds.
But the greenback has looked increasingly vulnerable this week as liquidity remained scarce and housing and employment data sagged.
Analysts said a Fed rate cut could further weaken the dollar, and yield spreads have moved decisively in favor of the euro in recent sessions.
That was despite the European Central Bank's decision to hold interest rates at 4 percent on Thursday, citing increased market uncertainty as reason for its wait-and-see approach.
But ECB President Jean-Claude Trichet said inflation remains a top concern, suggesting hikes may resume in the future.
The Bank of England, Bank of Canada and Reserve Bank of Australia all held rates steady this week. Only Sweden's central bank broke ranks, raising rates to 3.75 percent on Friday.
With Fed rate cuts now firmly priced in, "expect the euro to retest highs near $1.3850 ahead of a rally to $1.40 and above in the coming months," said Nick Bennenbroek, chief currency strategist at Wells Fargo in New York.
IT IS AMAZING HOW MUCH TRUTH IS IGNORED BY BULLS THAT ARE DETERMINED TO BE FULLY INVESTED AT ALL TIMES. ANY LITTLE BIT OF FAVORABLE NEWS SEND THE MARKET HIGHER, ONLY TO BE TRASHED THE NEXT DAY.
THEY ARE SO DETERMINED TO BE FULLY INVESTED, THEY ARE DETERMINED TO MOVE THE CHINA MARKET HIGHER BY THEMSELVES, REGARDLESS OF THE ACTUAL CHINA MARKET. COMPARE ^SSEC VS FXI AS WELL AS COMPARE THE INDIA, DAX, FTSE, BRAZIL ETC. IT IS SO STUPID TO BE FULLY INVESTED IN A DECLINING MARKET. IN MY JUDGMENT COMMERCIAL REAL ESTATE WILL GO INTO A MAJOR DECLINE, USUALLY 18 MONTHS AFTER THE BEGINNING OF THE RESIDENTIAL DOWNTURN. THEN ALL THE BANKS HOLDING DEVELOPMENT LAND AND PROJECTS UNDER CONSTRUCTION WILL BE FRIED. IT IS NOT GOING TO BE PRETTY AND MAY LAST 5 YEARS OR LONGER. 8,000 OR LOWER DOW IS CERTAINLY POSSIBLE BUT NOT ANY TIME SOON.
www.simplestockinvesti...
Currently, the pullback trendline on the S&P500 since December 9, 1994 predicts 1200, which we almost touched this morning. If it holds (and so far it is), we should see a bounceback to 1300~1350 over the next several weeks.