Saturday, August 20, 2011

Is the bear market far from over?

With last week's severe market decline, several international stock indices are now more than 20% off their 2011 peaks, a level that most commentators consider bear market territory. While the S&P 500 and most of our domestic stock indices aren't officially in bear market territory yet, the current market reaction feels like it is far more serious than just a garden variety market correction.



The news flow is eerily reminiscent of 2007-08 as the world was coming to grips with the severity of the crisis that gripped the global financial system. If so, we can expect more volatility in the months ahead, including both tradeable rallies and shortable declines. Again, this is no time to be a BUY-and-HOLD (BUY-and-HOPE) investor.



This essay by Comstock Partners sums up the bearish thesis quite well.



"What is currently happening in the market and the economy was predictable and is following the sequence we have long expected. Households accumulated enormous debts in the past decade, leading to the credit crisis and recession of 2007-2009. The government stepped in with massive monetary ease and fiscal expansion that produced only a weak recovery and a vast increase in government debt. The market erroneously assumed that the recovery would follow the pattern of typical post-war expansions and rallied strongly from the early 2009 bottom to the recent highs.



A similar pattern developed in Europe where sovereign debt of the weaker EU members has become a serious problem that EU leaders have been unable to solve. Now we are undergoing the aftershocks of the crisis.



As we have repeatedly stated, crisis recoveries are characterized by short sub-par recoveries and numerous recessions as household debt burdens dampen consumer spending for long periods. We did see the short sub-par recovery and now it seems to be ending at a time when the Fed has already used its best weapons and fiscal policy is due to become more restrictive. First half GDP was revised down sharply. Housing has continued to weaken. Consumer spending has been sluggish. Initial jobless claims for the latest period jumped back over 400,000. The ECRI leading index has declined to 127.9 from its April peak of 131.1.



Even more shocking was the plunge in the August Philly Fed Index to minus 30.7 from 3.2 in July. The drop was the weakest since October 2008. In addition, the August University of Michigan Consumer Confidence Index dropped to 54.9, lower than any level during the recession and the lowest in 31 years. These are the types of readings seen only in recessions. Although the Fed only recently lowered its economic outlook for the second half of this year and 2012 these projections already seem outdated. Today the New York Fed lowered its outlook while numerous brokerage firms and banks have belatedly been scrambling to cut their forecasts as well.



If anything the situation looks even worse in Europe. Germany reported second quarter GDP growth of 0.1% and growth in France was zero. Moreover European banks with exposure to PIIGS debt have been turning to the ECB for emergency loans. Today the ECB reported that one bank (not named) has borrowed 500 million Euros a day for seven days.



The remaining areas of the world cannot stop global GDP growth from shrinking. Japan is in a recession. China is still tightening to dampen inflation. China as well as the other emerging nations are export-driven economies that depend heavily on American and European consumers.



We, therefore, believe that the market has now entered a major downtrend. It is a mistake to dismiss the slide we've seen to date as mindless and devoid of fundamentals as many strategists maintain. These are not just scary headlines----they are scary fundamentals. As usual, there will undoubtedly be some more sharp rallies that will be interpreted as new bull markets. In our view, however, the bear market has only begun, and has a long way to go."









Returns for week ending 8/19/11



Returns for the past week:

Model portfolio: -3.46%

Actual managed account: 0.0%



NOTE:

While the model portfolio moved to a 50% invested / 50% cash allocation on 8/1, I have moved my managed accounts to 100% cash until the return vs. risk profile is improved. This accounts for the difference between model (hypothetical) and actual returns.

Saturday, August 13, 2011



Returns for week ending 8/12/11



Returns for the past week:

Model portfolio: +0.71%

Actual managed account: 0.0%



NOTE: The DecisionPoint timing model threw a NEUTRAL signal on 7/29. While the model portfolio has moved to a 50% invested / 50% cash allocation, I have moved my actual managed accounts to 100% cash until the return vs. risk profile is improved. This accounts for the difference between model (hypothetical) and actual returns.



Sunday, August 7, 2011

Where are we? Comparing 3 secular bear markets...



Click to enlarge chart



Another interesting commentary and chart from Doug Short, implying that our current secular bear market may have a ways yet to run...



Doug Short, "It's time again for the weekend update of our "Real" Mega-Bears, an inflation-adjusted overlay of three secular bear markets. It aligns the current S&P 500 from the top of the Tech Bubble in March 2000, the Dow in of 1929, and the Nikkei 225 from its 1989 bubble high.



The chart below is consistent with my preference for real (inflation-adjusted) analysis of long-term market behavior. The nominal all-time high in the index occurred in October 2007, but when we adjust for inflation, the "real" all-time high for the S&P 500 occurred in March 2000."

What does a 4% down day mean re: Market Condition


Interesting commentary from Doug Short, saying that the -4%+ down day last Thursday indicates that the bear market has resumed.

Doug Short, "My tentative conclusion is that, at least since the onset of the 21st Century, declines in excess of 4% happen in cyclical bear market declines. The one outlier during this time frame was a 4.28% decline on April 20 2009, about six weeks after the 2009 low. So, if you're looking for a glimmer of hope, there is one 21st Century precedent for 4% plus down day in a cyclical bull market. But the overall perspective is not encouraging. "

Note that in the 2000-03 bear market, A couple of the 4% decline days punctuated the market trend's important reversal points, providing a leading indicator of trade-able counter-trend rallies lasting multiple weeks. This is quite different from the 2008-09 bear market, where the 4% decline days were mostly followed by more selling, perpetuating the waterfall decline without a pause for a counter-trend rally. I believe the difference between the two bear markets was that the first was due to a normal business cycle recession whereas the last was due to a financial crisis.



click chart to enlarge

Returns for week ending 8/5/11

Returns for the past week:
Model portfolio: -4.6%
Actual managed account: -0.7%

NOTE: As noted here last week, the DecisionPoint timing model threw a NEUTRAL signal on 7/29. This proved to be a timely signal, enabling our portfolio to neatly side step last week's waterfall decline.

While the model portfolio shifted to a 50% invested / 50% cash allocation on Monday, as noted here, I moved my managed accounts to 100% cash until the risk vs. reward improves. That accounts for the variance between model returns and actual returns shown above.

Investor sentiment is currently extremely negative (extreme FEAR), pushing stocks to lower prices where return vs. risk is vastly improved. It is useful to think of investor sentiment as a pendulum, swinging from one etreme to another over a period of weeks and months. Once FEAR measures begin to show that FEAR is dissipating, I intend to invest up to 50% of my funds in the model portfolio stocks while awaiting a fresh BUY signal from the DecisionPoint timing model.