Equity markets took a badly needed turn for the better last week. We wrote in last week's comment that technical and sentiment indicators were positioned very similarly to conditions in mid-March, the time of the last intermediate-term low in the stock market, which supported the idea of an imminent bottom and subsequent relief rally. As it turned out, markets became even more stretched on the downside early last week before snapping back. In Tuesday's washout session, a record number of issues traded on the New York Stock Exchange fell to new 52-week lows.
We have thought that an interim bottom in the financial stocks and an interim top in the oil market were needed to turn the broader stock market around, and that is exactly what happened last week. After falling a spectacular 40% over ten consecutive weeks, bank stock indexes reached a selling climax last Tuesday, and rebounded a remarkable 30% by Friday's close. The capitulation and subsequent powerfully reversal we saw in the financial stocks last week is a strong indication that the worst is over for the broader stock market for a period of time.
In addition to the reversal in financial stocks, falling crude oil prices provided an atmosphere for stocks to rally in the second half of last week. Crude prices tumbled $16, or 11%, last week (the largest weekly dollar decline ever) to close under $130/barrel. Gasoline and Natural Gas also dropped in excess of 10%.
With financials having recorded a capitulation bottom and commodities in corrective mode, short-term inter-market trends have improved and suggest that a relief rally has begun, though some very near term backing and filling should be expected. Following the last important low in the stock market in mid-March, the S&P 500 embarked on a rather spirited two month, 13% rally that took the index all the way back to its 200-day moving average. We are skeptical that this relief rally has that much potential but we will take it one week at a time.
Our overriding premise is that this remains a bear market; the stock market, and especially the financial sector, discounted a lot of bad news over the course of the past two months, but we continue to believe that the de-leveraging process associated with the unwinding of the credit bubble will continue to create more negative than positive surprises in the economy and the stock market.
On the topic of the ongoing financial crisis afflicting the U.S. economy, there was an outstanding piece entitled Why No Outrage? (.pdf version) in Saturday's edition of the Wall Street Journal written by James Grant, editor of the eminent Grant's Interest Rate Observer. Those who are interested in reading the full article can click on the link above. Alternatively, a few of Grant's most provocative observations are excerpted below:
"Through history, outrageous financial behavior has been met with outrage. But today Wall Street's damaging recklessness has been met with near-silence, from a too-tolerant populace."
"Late in the spring of 2007, American banks paid an average of 4.35% on three-month certificates of deposit. Then came the mortgage mess, and the Fed's crash program of interest-rate therapy. Today, a three-month CD yields just 2.65%, or little more than half the measured rate of inflation. It wasn't the nation's small savers who brought down Bear Stearns, or tried to fob off sub prime mortgages as "triple-A." Yet it's the savers who took a pay cut -- and the savers who, today, in the heat of a presidential election year, are holding their tongues."
"Have the stewards of other people's money not made a hash of high finance? Did they not enrich themselves in boom times, only to pass the cup to us, the taxpayers, in the bust? Where is the people's wrath?"
"One might infer from the lack of popular anger that the credit crisis was God's fault rather than the doing of the bankers and the rating agencies and the government's snoozing watchdogs."
In 2004, after the Greenspan Fed had held the fed funds rate at an astonishingly low level of 1% for a full year "...began one of the wildest chapters in the history of lending and borrowing. In flush times, our financiers seemingly compete to do the craziest deal. They borrow to the eyes and pay themselves lordly bonuses. Naturally -- eventually -- they drive themselves, and the economy, into a crisis. And to the scene of this inevitable accident rush the government's first responders -- the Fed, the Treasury or the government-sponsored enterprises -- bearing the people's money. One might suppose that such a recurrent chain of blunders would gall a politically potent segment of the population. That it has evidently failed to do so in 2008 may be the only important unreported fact of this otherwise compulsively documented election season."