On March 9th of this year we were on Bloomberg TV discussing why we thought the stock market could rise anywhere from 20-25% because it was more oversold that it had ever been since the Great Depression, and the sentiment was at record bearish levels. The S&P 500 at 670 was 35% below the 200 Day Moving Average --showing an extreme oversold condition, and the American Association of Individual Investors showed a record of 70% bearishness (as well as other bullish sentiment indicators). The very next day the market started up into what we would consider to be a counter-trend rally that has just yesterday taken the S&P 500 up 20% to the "old" support and now resistance level of 804. If this counter trend rally (or secular bear market rally) were to rise 25% that would take the market to 838 and our worst case (for the bears anyway), in our opinion, would take the market as high as the "old" resistance area of 878 on January 28th of this year. That would be a rise of about 30%.
We are astounded to see how many stock market pundits are absolutely SURE that this is the start of a new bull market with the low made at 670 in the first week in March. The reason we are so surprised that everyone is jumping on the bull market bandwagon is that this was the same reaction they had in every counter trend rally since the S&P 500 peak of 1576 on October 12th 2007. They thought the market bottomed at 1200 on July 15th 2008 on the way to 1313 on August 11th. Then they thought the market bottomed at 840 on October 10th 2008 on the way to 1007 in November. Then they thought the market bottomed at 741 in November of 2008 on the way to 944 in January. And now, after all those misguided judgments about the market making a firm low, and without any reservations, they have now also just recently jumped head first, with their matador outfits blazing, onto the bull bandwagon. And this recent bear market leg down took-out a clear trendline at 825 on the way down, then the strong support of 804 as well as the major support of 741 reached on November 21st of 2008.
Maybe the reason it was so easy to get aboard the bandwagon was not technical in nature but more fundamentally based. For example, we did get relatively stronger retail numbers, housing affordability continues to reach new historic highs, housing starts rose unexpectedly this week, industrial production was not as bad as the estimates, and the PPI and CPI rose enough to take the deflation risk "off the table" for many people. In addition, we have a promising new administration in Washington with hopes of rectifying the debt buildup of the previous eight years and an incredibly accommodative Federal Reserve Board.
We will give you our slant on each one of these fundamental arguments. The latest retail sales, which were better than expected, were largely due to consumers responding to discounting as retail stores lowered prices to get rid of excess inventories. In order to have a sustained increase in personal consumption, wealth has to increase, and over the past 7 months consumers have lost over $11 trillion of wealth (or 23% of net worth).
Housing affordability is a reflection of interest rates declining, but if the buyer can't come up with the 20% down payment and/or can't qualify for a loan, there is no sale. The fact that housing starts rose last month is not positive for the housing market, but in fact, it is bad for the housing problem since it adds to an already bloated inventory. Housing prices went through a financial mania that was comparable to the dot com bubble of the late 1990s and, in our opinion, will not stop going down until it reaches the norm of 2.75 times family median income or lower, (chart attached).
If industrial production was not as bad as expected, it was still down 1.4% and has been down for 5 of the last 6 months and down 11.2 % over the past year. The CPI and PPI rose more than expected which caused everyone that was worried about deflation relax. However, over the past 12 months the PPI is down 1.3%, the largest annual decline since 2002, and the raw and intermediate segment of the PPI fell 4.5% and 0.9% respectively. These negative numbers of raw and intermediate goods will eventually work their way into the headline numbers of both the PPI and CPI in the future.
The new administration has been much more transparent than the last, but as we stated in a couple of earlier comments, once Obama sees the problems he has inherited, he may ask for a recount on the presidential vote. The bailouts and stimulus programs continue to add to the public debt while the private debt should continue declining. We will not work our way out of the powerful forces of deflation until the enormous total debt of $52 trillion ($26 trillion was generated over the past 8 years) continues to unwind (see attached Cycle of Deflation). The fact that over $30 trillion of wealth has been wiped out worldwide has made our national problem even worse.
The Fed is doing its best to "paper over" the problems but there are unintended consequences to this strategy. Most investors think that the unbelievable printing of money will lead to major inflationary consequences. We believe that could come eventually, but presently, we still believe the major battle is deflation and until a substantial portion of the debt is liquidated it will continue to be the problem. Right now the Fed is attempting to generate more borrowing and spending by the U.S. consumer. But the reason we are in this mess in the first place is borrowing and spending, so doing more of the same is not the solution. Yesterday, the Fed announcements were taken as a positive for our economy and we sure hope and pray that it will work. However, we believe that this "money printing" is more of a stealth protectionist move of currency devaluation. We expect our trading partners to follow in our footsteps after watching the U.S. dollar collapse. In fact, they have to keep their currencies competitive with ours in order to export to us. Because the global economic problems rank right up there with ours and the fact that they are so dependent upon exports to the U.S. consumer, they will not be able to grow if the U.S. dollar continues declining.
To summarize, we believe the market has not made its bear market low on either a technical basis or fundamental basis.