Three Positive Developments for Equities

The stock market has a way of humbling everyone at one point or another. The last five trading days have seen the DJIA and the S&P 500 fall more than 17%. There have been wild swings and late day market plunges and I do not know any market observer that isn’t white knuckled with anxiety for what could be ahead. Allow us to point out a few positive developments which could signal that a market bottom is near.

First of all, when evaluating the stock market one must consider both the fundamentals underlying individual stocks as well as overall market psychology. We would argue that in the present market, emotion, or more precisely - “investor sentiment” - is overriding fundamental economic factors virtually across the board. There is a climate of fear, uncertainty and doubt (FUD) which has been generated by the failings of many formerly revered financial firms as well as the unprecedented government intervention in the form or rescue packages, rate cuts, bailouts, etc. Just Thursday a Wall Street Journal survey of economists placed the odds of recession over the next twelve months at 89%, up from 60% last month. (Hey, at least it wasn’t 100%).

So, the market has almost everyone jittery if not in full panic mode. There is one sentiment indicator that we pay particular attention to in our bi-weekly newsletters, which is the percentage of NYSE stocks selling above their 30-week moving average. It probably is not a surprise that out of the broad-based NYSE, only 1.66% of stocks are trading above their 30-week moving average. While that may not be surprising, it is still significant. We have been tracking this indicator since June 1998 on a weekly closing basis. The previous low for this sentiment indicator was 11.9% in July of 2002, which as you will remember was a great time to get back in the market. Normally, when this metric gets below 25% we see it is a strong bullish indicator, and has never been this low in the last 10-plus years.

Second, note that General Electric’s (GE) earnings came in as expected Friday morning and the company is reaffirming its earnings guidance for the full year. Profits fell by 22%, much of that attributed to GE Capital—GE’s finance arm. But even GE Capital’s news was not nearly as bad as some had feared as it earned $2 billion in the quarter. So, while GE did not blow the doors off, the company did what they were expected to do. GE has endured a very rough go of it lately and its exposure to consumer debt is risky in this environment. However, the company is a hugely diversified company that continues to grow despite a challenging operating environment. The company also has a backlog of $170 billion in orders, which is roughly a year’s business and should be of some comfort to shareholders. With GE and IBM (IBM) reporting relatively strong quarterly results, perhaps the market will find the foothold that it has been searching for at the beginning of this earning season.

Last, Overnight LIBOR rates dropped 51% Thursday night to 2.469%! Big deal? Yes, it is. This is predominantly a global credit crisis as the credit markets which lubricate commerce worldwide have literally seized up over the past few weeks. This dire situation is best measured in looking at the spread between the Overnight LIBOR rates and that of other, U.S. based short term rate benchmarks. That spread has been enormous lately, indicating that overnight inter-bank lending had literally frozen up. The fact that the Overnight LIBOR rate dropped this dramatically Thursday night seems to indicate a general thawing in the credit markets that should be greeted with great fanfare by despondent market participants.

So, even in some of the most turbulent times in the stock market’s history, there are positive signs. In the past, times of cheap valuations and extremely bearish sentiment were great times for selective long-term buying. However, even though valuations are historically cheap right now, as I stated before, this market is being controlled by FUD. We are advising cautious buying as we think that the bloodletting may continue a little longer, but long-term investors will be pleased to get some of the high quality stocks at depressed prices because many stocks have incurred an unjustified overreaction by this highly emotional market.

Disclosure: Ockham Research does not own or trade in any of the securities mentioned in this article. However, Ockham Wealth Advisors an independent Registered Investment Advisor that utilizes the Ockham Research methodology and research, does have a long position in GE. Ockham Research LLC does not stand to benefit monetarily from this relationship.

Comments

[User 143167:]

Overnight Libor is too volatile too predict a thing. You should look at the 3M Libor.

2008 Oct 12 02:17 PM

[Jim Hawthorne:]

Your final paragraph tends to contradict the first, in which you speak (correctly) about humility.
With all humility, let me suggest that the last thing you should be doing is offering predictions based on real or imagined "valuation" at the current time!

By all means, be humble. If not, this market will surely do it for you!

2008 Oct 12 08:32 PM

[whidbey:]

I think your indicator was meant for over valued stocks.

Distinguish that from a market starved of funds, where selling has largely been driven by the need raise money to fight again another day - survival as financial entities.

The we are not sure the hedges and retail mutual fund holders are persuaded that the emergency money raising is over. Twice bunt and we are all gun shy. But, it may not be over.

This is the time in every market cycle when we must wait to let the market point the way. One or two swallows do not a spring make. But you have made me feel better none the less. And I am happy to learn something from you.

2008 Oct 12 08:37 PM

[TinyMIghty:]

We are not making higher low and higher high yet... I do not want to catch a falling knife.

2008 Oct 12 09:18 PM

[Moon Kil Woong:]

LOL now anyone can make up their earnings. SEC just issued orders that lets GE declare any value they want to any asset that is too garbage to sell. No wonder no one will lend any money to one another. They didn't suspend market to market, they instituted a chaos for lies policy. Will you lend me your money. I promise I am good for it? Trust me, the market says it's junk but I say it's worth $0.95 on the dollar.

2008 Oct 12 11:59 PM