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Market Parallels That Shouldn't Be Ignored
"The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation - usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs - during this extremely flashy move, the US has shed 2.5 million jobs (as many as were lost in the entire 2001 recession)."
The markets rise. The economy sinks. It is not sinking as fast as it was. But it is still going down. Month after month, the number of people without jobs increases. Even Paul Krugman says that unemployment won't reach its peak until 2011.
From Me:
Many have pointed out that unemployment is a lagging indicator. I also accept this to be true. It is also said that the consumer is 70% of the economy. If pro-government/liberal economists like Krugman don't think we'll see peak unemployment until 2011, and even the White House says we will not peak until at least the second half of 2010, I believe it's safe to say that we are in for decreased consumer activity.
Because we are far from the summit of unemployment, the suggestion is that the economy still has a profound decline ahead of it for at least the next year. Furthermore, when compared to the crash of 1929, the 2008-2009 crash now share something in common: A rapid 60% gain off of the "bottom." What followed this gain seems to have been forgotten by many: A nearly 90% decline over the next two years. Often 1929 is portrayed as the great crash, but in fact it was mid 1930 to mid 1932 that produced the most pain for stock market participants who were long. Lack of credit was seen as a major culprit in this severe decline, coupled with high unemployment. What we are experiencing right now is unemployment that is approximately 1/2 to 2/3 as severe as the Great Depression, and credit markets that are equally tight despite government/Fed efforts to make credit more available.
By the time the unemployment peaks, it is possible we will reach levels of unemployment very close to what was experienced during the Great Depression. The data points are clearly pointing in this direction, and unless the credit markets relax these two major aspects of the Depression will be in place. If history is any indication of what will happen next, those long in the market should take note and use protective stops to lock in profits on a market decline.
Short term traders could still benefit from buying on dips, but longer term traders may find themselves facing a substantial decline. Many shorts have already covered their positions, and insider selling is occurring at a ratio of about 33 to 1 (33 times as much insider selling as buying). This is "smart money" that is in the know. These are individuals and institutions that are part of or close to the process of economic activity and they are net sellers by a factor of 33 to 1.
I used to be a value investor until 2008 taught me that value didn't matter. Great companies with cash, growth, and "value" suffered catastrophic declines along with their much weaker competitors. If and when the market experiences a great decline, nearly anyone who is long will suffer greatly. No amount of research or fundamental strength will overcome a general market in catastrophic decline. I am not suggesting that we will absolutely suffer a nearly 90% decline as was seen in the early 1930's. I am suggesting that a correction of at least 35% to revisit the March lows is not only possible, but probable.
The only way I see this not happening is if employment figures can be improved in short order, coupled with the loosening of credit. This would have an inflationary effect on prices (and devaluation of the dollar) and stock prices would be affected as well. A falling dollar would prop up the prices, but ultimately the "value" of those stocks would decline unless they grew at the rate of inflation (doubtful). In the short term I believe we will continue to experience some mild deflation, but in the longer term I believe inflation will rule the day. One way to possibly insulate a portfolio from these effects is to purchase gold and silver. However, these metals have had a recent run up and are now on the decline. I am looking to add silver positions once silver falls about 10% from the recent highs. If we assume unemployment will peak around Q1 2011 (extrapolating from the government's numbers and Krugman's), then as a lagging indicator that would suggest we could see market recovery in the second half of 2010. Recovery? Recovery from what? Didn't we just recover? And therein lies the question of what the next year will bring in the market......
Disclosure: No Positions