Wednesday, March 26, 2008

Slow decline

The S&P 500 has been in a declining channel pattern since mid-January.

The first break outside of this channel will probably indicate the direction of the next market trend. I'm predicting that the S&P index will eventually drop to 940, (30% lower than today) so any upward break would probably be temporary. A downward break on the other hand would likely herald a short and steep decline to new lows.

Friday, March 07, 2008

S&P 1500: A long-term upper limit?

The stock market is powered by emotional, flawed, and irrational human beings, and prices are not as logical as some might wish to believe. One of the best examples of this irrationality is that it took more than 16 years and five bear/bull cycles for the Dow Jones Industrial Average to decisively cross the four-figure threshold of 1000. The Dow 30 reached 1000 for the very first time in January 1966, but it wasn't until November 1982 that it first passed above 1050. In the intervening one and a half decades, the Dow fell to the 600-800 range and returned to the 990's five times.

There was nothing special about Dow 1000 financially or economically. Corporate earnings grew throughout the stretch of 1966-1982, so Dow 1000 did not represent a particular P/E ratio - it would have made just as much sense for the market to have a limiting price of 900 or 1100. In addition, four of the companies in the Dow 30 were actually dropped from the index and replaced with new ones during that span, so the index didn't even measure the same thing over those 16+ years. It was obviously the psychologically important change from the 3-digit index level of 999 to the 4-digit level of 1000 that kept that barrier in place for all those years.

Today the S&P 500 is the more recognized measure of the market, and this index seems to have formed a long-term upper price limit around 1500. In 2000 the S&P made brief excursions above 1500 before succumbing to a bear market and falling to 776 by October 2002. The S&P then recovered by 2007, and spent several months passing above and below 1500. After reaching a high of 1565 in October, it now appears that the S&P 500 is retreating from 1500 for the second time. If the previous long-term market top from 1966-1982 is any indication, then it wouldn't be surprising to see the 1500 barrier remain in place until the middle of the next decade.

Tuesday, March 04, 2008

Final poll results

The polls are now closed for the market bottom and investment choices.

Market bottom: The majority of blog visitors believe the Dow will bottom out either above 11,000 (36%) or between 9000 and 11,000 (32%). The remainder were evenly split between 7000 to 9000 (15%) and below 7000 (15%). My forecast for 8500 is definitely in the minority.

Investment choices: Visitors were allowed to give multiple answers here, and 2/3 of the responders indicated they owned stocks or stock mutual funds. Cash and short (bear) positions were each present in about 1/3 of the portfolios. Bonds, options, and "other" were each represented by 2 of the 25 surveyed. I wonder what "other" means? Real estate perhaps?

I'm in a combination of cash and bear funds, which is in the minority in terms of bull vs. bear bets.

The next bubble (still open): I'm happy to see a relatively even distribution of answers here. The most popular guess for the next bubble is emerging markets (36%), while the least popular is commodities (10%). Sixteen percent of responders went out of their way to indicate that the next bubble was not on the list of choices; if any of those folks would like to share their thoughts, please feel free to leave a comment!

Given my forecast for a painful bear market/crash to come, I think many of the stock and mutual fund holders in the survey will be selling en masse at some point this year. I also think individual forecasts for the market bottom will change as the market falls and more bad news comes out. I wanted to collect opinions now before the gloom really sets in - like taking a survey in 2000 instead of 2003.

Thanks to all who participated!

Saturday, March 01, 2008

Bear market on schedule

The S&P 500 lost 3.5% in February, which ended up being neither flat nor a fool's trap. Instead, the bear market is plodding along without much regard for the time of year. With Friday's close of 1330, the S&P is now down 15% from the October 9 high, and is only 20 points away from crossing the low of 1310 on January 22.

My long term forecast is unchanged, and I'm still expecting a market bottom around 8500 on the Dow and 940 for the S&P. Based on the schedule of the 1946 crash, there may be another month or so of flat market performance before the main event gets underway.

From a fundamental standpoint, things have only gotten worse on Wall Street, and there's really nothing that Bernanke or Buffet can do about it:
  • The Federal Reserve's lowing of interest rates has taken the squeeze off of some homeowners, but banks and other lending agencies are still being tight with their money out of fear of future defaults and write-downs. This reduces the availability of every kind of loan, including home, auto, and student loans for college.
  • The resulting lower bond yields are making U.S. Treasury bonds less attractive to foreign investors. Much of the $9 trillion federal debt is financed through sales of Treasuries, so reduced demand will only hasten the decline of the Dollar and lead to more inflation here at home.
  • The corporate buyback binge continues unabated. In fact, stock repurchases are so large now that some companies are borrowing money to finance them! Last year for instance, IBM borrowed $11.5 billion solely for the purpose of buying back shares. This only hurts long-term owners of IBM stock, since IBM will have to pay off these loans at the expense of the already tiny dividends. Why not forget the buybacks and simply pay shareholders with quarterly dividends instead of paying banks with monthly loan payments?
In short, all signs indicate that U.S. stocks are still highly over-valued, and that the bear market will continue.