Rational Advisor

I know, the US market has declined by 20% from it’s all time high. And Oil prices are still too high, the housing market continues to fall, and autos are still in a real mess. Jobs have been lost almost every month this year. The Banks keep on writing down assets and need help. The airlines can’t even afford to give you peanuts, you have to buy everything on their, including the pillow. Israel is threatening to bomb Iran (sounds like a beach boys song “Bomb Bomb Bomb, Bomb Bomb Iran, Bomb Bomb Bomb, Bomb Bomb Iran, Oh yeaaa…”, Russia after Georgia, tomatoes are full of salmonella and 9 out of 10 people believe the world’s going to end (Only 9 out of 10???

Is it really the end of the world?

Although things look dire, most economic reports have consistently proven to be better than the fears.

No doubt, the economy is seeing a slowdown, but it’s not collapsing.

What has collapsed is Consumer confidence and investor sentiment. What we have is generalized fear!

The US consumer confidence index recently declined to one of it’s lowest levels ever recorded. Currently this index is about 10 percent “below” its worst reading during the entire 1982 recession – a recession widely recognized as the worst ever since the Great depression! By comparison, on 1982, annual real GDP growth was -2.7 percent (today it is +2.5 percent); the unemployment rate peaked at about 11 percent (today it is about 5.5 percent); job losses from the peak amounted to 2.8 million jobs or 3.2 percent of the job base (compared to only 0.4 million job losses in the US, or about 0.32 percent of the job base today); the core rate of inflation was above 10 percent (today it is around 2.3 percent); and the 10 year US Treasury yield was above 14 percent (today it is below 4 percent). Is today’s environment really 10 percent worse than, or even nearly as bad as, it was in 1982?

Even if economic news remains alarming, it’s how to see how this miserable confidence and sentiment could get much worse. And this may be the best news there is. Since current economic sentiment is already much worse than even a bad economy reality, financial markets may offer greater upside and less risk than widely perceived.

Non-Financial companies continue to enjoy positive profit growth (even though it is lower than some analysts trumped up expectations) and healthy balance sheets, what is lacking is not the ability to hire, but rather the confidence! Corporate confidence has remained cautious throughout this recovery causing most to avoid “over-hiring”. Consequently, the job losses this year seem mainly due to “suspension” of new hires rather than the more common “surge in layoffs”. However, the slowdown in job creation, like much of the rest of the economy remains highly concentrated among the housing and auto industries. Should job conditions show signs of stabilization, rather than further erosion, the entire outlook for economic growth and thereby confidence could improve quickly.

Oil price pressure has been a major negative on inflation. However, many oil crises have been seen since the late 1990s, which were supposed to send the consumer into recession? Somehow the consumer survived.

Non-energy prices remain remarkably tame. In past oil crises, core inflation often surged, combining with energy prices to destroy household purchasing power. Today, the consumer is still enjoying “deflationary electronics pricing” falling apparel prices and lower new sticker auto prices!

Macroeconomic policies have been persistently and aggressively accommodative since this crisis began almost a year ago? Money supply growth has accelerated sharply, both short-term and long term interest rates have dropped, the yield curve which was inverted is now positively sloped. Remember economic policies typically have about a one year lag time and thus these measures have not yet begun to positively impact economic activity. But they soon will!

Since early this year, we think the stock market has been in a bottoming mode. Similar to the triple stock market bottom after the dot-com bust when the S&P 500 challenged the 800 level three times (July and October 2002, and again in March 2003).

The stock market has held about at previous lows despite an impressive set of negative forces:
- a surge in oil prices
- a technical test of a bear market 20 percent sell-off
- continued mortgage and banking fears
- continued fears of the auto sectors collapse
- geopolitical scares such as Iran, and Russia

Considering these forces, the stock market has perhaps held up better than widely perceived. At minimum this is a very significant “third test” of the crisis lows, and should the market hold and rally from these levels, it may well indicate that the worst is over.

The world seems a scary place – ongoing wars, imminent was risk in Iran, still high oil prices, collapsing stock markets, falling house prices, bank write downs, no jobs, lower profits and a widespread recession belief

What idiot would be investing in this market?

And yet, this is precisely why you should be in the market. Sellers know it is going to be bad and have already sold. They are sitting on the sidelines with their “dry buying powder” waiting for the storm. However, if the sun unexpectedly comes out, a lot of the buying power will need to find its way back into the stock market!

Financials are extremely cheap relative to energy stocks. Monetary officials have been attempting to help financial fundamentals and pessimism is indeed very high! S&P energy stocks are more highly priced relative to S&P financials than at any time since at least 1965! This implies financials are cheaper today compared to energy stocks than during the height of OPEC crisis that was combined with the world debt crisis, or during the banking S&L crisis of the early 1990s!

The pain investors have felt since the October market top - bad as it has been - still isn’t as awful as the average 30% bear market drop nor has it gone on as long. And it pales in comparison with some of the blackest periods of market history, like Oct 19, 1987 or, the 2001-2002 bear stretch.

The average bear market since 1929 has been about 18 months. Since 1956, however the average duration has been about 14 months. The average decline since 1929 has been 38.2% versus 31.8% since 1956. It has taken the S&P 500 about 5.2 years on average to recover from its bear market highs since 1929. since 1956 the average recovery time from a bear market comes to about 2.8 years.

Although speculators need to figure out the exact hour when the stock market will bottom, fortunately for investors this question is not that important. Rather investors need to consider how they will feel sometime over the next 24 to 36 months if they buy today.

Although past perfromance seldom guarantees future results, however, one thing willr emain true - investors who are greedy when others are fearful will reap benefits over the next few years.

Everyone take a deep breath. Now, exhale!