Thursday, November 6, 2008

Have we reached the bottom?

With the S&P 500 being down over 30% year to date investors are getting nervous about their sinking retirement accounts. Many are simply throwing the towel and converting a majority of their stock mutual funds into bond funds in order to prevent their investments fall further in case we experience the next great depression.
Still there are some brave souls out there who are either keeping their retirement contributions or even increasing them.
With the stock market charts drawing steep vertical declines for September and October, and the VIX reaching multi-decade highs many investors are wondering if we have reached a bottom. Fundamentals might be deteriorating in the near term; however that shouldn’t mean that the stock market should keep going lower. When the stock market hit its all time highs in early October 2007 almost everyone was bullish on stocks. Furthermore the financial crisis was still in its infancy as few investors had the vision to foretell the complete meltdown of the system including failures at Lehman, Bear Stearns, AIG or Fannie and Freddie. So what are the charts saying?

The market has been in a consolidation mode ever since it hit its lows for 2008 in October. The market is over 15 % above its lows for the year as of now. The major market indexes ignored the news about the contraction of the US economy in the third quarter and the slump in consumer spending by recording their biggest weekly advance since 1974. The rosy short term situation would definitely end on a decisive move below the year lows at $83.58.
During bear markets there usually are several bear market rallies which cause major market indexes to rise significantly off their recent bear market lows. Another feature of most bear markets is analysts trying to time to bottom at the expense of investors. I did try doing exactly the same in March as well. The thing is that as long as the market keeps making lower highs and lower lows, then the technical picture is bearish. If the market breaks the pattern of lower highs and lower lows, it could then start charting a bullish picture for equities.
Levels to watch on the upside include 105.53, which was a reaction high straight from October lows and is close to a 50% retracement of the last leg of the bear market from the August lows. Other levels to watch on the upside include 113.15 as well as the 120-124 area. I see the 120-124 area as the toughest to break out of as it previously marked 3 intermediate term bottoms in 2008.

Full Disclosure: Long S&P 500
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  1. to really understand how good of a deal stocks are right now, we need to look at a much longer time period...i suggest 80 years. over the long term, equity values are bounded by earnings...period. since the 1920's, earnings have grow at 8-10% per year; not surprising, so have stock prices. i suggest the following analysis: graph monthly s&p 500 returns from 1925 ad covert to a logrythmic scale. draw a regression line through the results (excel has a function called logest). this line measures the long-term growth rate of us equities as measured by the s&p500. you will find several important conclusions: 1) october's correction brought stocks below trend growth for the first time since 1997, but just barely (8%). this is very bullish. 2) however, you will also note that, based on previous bottoms, we could have a long way to go before stocks bottom (s&p500 @ 500 or so). and 3) the market will normally spend several years above or below trend growth before it fully recovers. this does not mean equity values won't grow; what it means is that investors could have to wait several years before fully realizing the full value of their equity holdings. the bottom line is that we should be prepared to invest consistently over the next 24 months but not to go all-in right now. the recent, dramatic moves in stocks has only brought us back to long-term equilibrium...we are not yet trading a steep discounts

  2. JB,

    Thanks a lot for the insighful comment. I am fully equipped to wait for the markets going sideways as long as my dividend checks keep coming in.
    If you are interested in preparing this analysis as a guest post on my blog this guest post, be my guest and e-mail it to me at dividendgrowthinvestor at gmail dot com.

    Or if you have a blog write it there and I will link to it.

    What I tried to compare in this post is the technical picture using price charts ( something I do rarely on this blog)

    Best Regards,

    Dividend Growth Investor


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