We have made quite a few predictions over the past years and even over the past few months. As you know, we wrote a special report in September of 2003, "The Catalyst for the Next Deflationary Bear Market---Real Estate". We also wrote on December 22, 2005 "Softening Housing Market Puts Global Economy at Risk". In fact we discussed housing so much that if you click on any recent weekly reports and scroll down to the bottom of the recent reports on the right you will find "Archives Search" and if you type in "housing" you will find that there were 262 reports that dealt with the housing problem since first writing these reports.
We have predicted a severe "global recession" for many years and if you search the archives for that it appears 17 times. Just recently we predicted (and showed in all the charts of "The Cycle of Deflation") that there would be a race by all the Central Banks to lower interest rates in order to enhance exports. Just last week the Bank of England lowered their rates from 3% to 2% (lowest since World War II) after lowering them in November TWICE. The ECB lowered their rates the most in their 10 year history from 3.25% to 2.5%. They also lowered rates TWICE in November. Japan's central bank lowered their rates as well as Switzerland's, the Czech Republic's, Korea's, Australia's and the list goes on and on.
We predicted in "Obama May Want a Recount", November 6th that Obama would inherit a $1 trillion or more deficit in the coming fiscal year. We were probably low with that prediction since just today it was reported that the November budget deficit registered a new record of $164.4 billion and is on track for a record deficit of $1 trillion. A deficit of $1 trillion for the year would set a new record as a percent of GDP since World War II at 6.7%.
On July 3rd we predicted that commodities would peak shortly and decline with the severe global recession dampening the demand. The next week, July 10th in "Explanation of The Predictions Made Last Week" we stated, "Many investors believe that the stock market has been going down for the past 8 months because of the rising prices of energy and food. We believe that the market will continue down with the decline in the U.S. economy along with the decline in the global economies. And even if the energy complex as well as other commodities weakens, we think the stock market will continue down until it reaches reasonable valuations." Commodities peaked in early July and the stock market declined along with commodities (A CRB chart and the charts of some commodities by the Chart Store are attached.)
Now, for the first time in many years there is some change in the way we are thinking about the stock market. We are in the 8th year of a secular bear market and the market has plunged since the October 2007 peak. At today's close of 873 the S&P 500 is selling at 13.2 times 2008 trendline reported earnings, the lowest P/E ratio since 1987, and below the long-term average of about 15. The average low trendline P/E ratio of bear markets associated with economic recessions is 10.4, not far below the 11.2 reached at the 741 S&P low on November 21. Therefore it is possible-though not probable-that the bear market low was made on that date.
There are two major reasons we think the market can bottom at significantly lower levels well into 2009. First, in 5 of the last 10 bear markets connected with recessions the P/E ratio bottomed at 8 or under. We think that this is a strong possibility this time as a result of the severe nature of the current global credit crisis and recession and the likelihood that this is a secular bear market. A P/E ratio of 8 on next year's trendline S&P 500 earnings of $70 would bring the index down to the vicinity of 560. Second, stocks have tended to bottom about 5 months before the economy, and we would be surprised if the economy bottomed 5 months from now. Therefore if the economic bottom was pushed out beyond the 2nd quarter of 2009, the market probably would not trough until well into the year.
Having said that, however, the market is now somewhat undervalued for the first time in many years. In previous years we believed correctly that the market was highly overvalued and that the economy vulnerable to a sharp contraction. We therefore had two major factors indicating a highly risky market. Now the market is much cheaper, but we still think the credit crisis is ongoing and that the economy is contracting at an alarming rate. The market is thereby subject to a tug of war between a more reasonable valuation on the one hand and the prospect of a long and deep recession on the other. In addition if the market bottom eventually occurs well into 2009 as we believe, a bear market rally is a strong possibility between now and then. Therefore, although we believe the market lows are still ahead us, the road to the bottom is likely to be choppy and highly volatile, ending finally in a massive capitulation on the downside.
