Friday, April 25, 2008

Optimism returns

The S&P 500 index passed below 1400 on January 15th, and it has spent all but four days since then in the 1300's. Several sentiment indicators have been turning more optimistic during this market pause, and this makes the market vulnerable to further declines.

The only area where pessimism still reigns is in the short interest ratio, and it remains at historically pessimistic values. As long as short interest remains so high, it will limit somewhat the market's ability to fall. In other words, any decline from here will probably be excruciatingly slow, rather than sharp and sudden.


Anonymous said...

This is stuff from MarketWatch. The Investors Intelligence survey April 15th "showed 37.8% of newsletters were upbeat vs 30.9% in mid-March, which was the lowest since 2002 and 38.9% of newsletters were bearish and 23.3% were in teh correction camp, expecting market declines but hopeful of buying opportunities". The techicals seem to be signaling a bull run and the "new highs/new lows" seems to be moving away from "bearish extremes". Consumer discretionarys have outperformed the market which might signal that the overall market will follow higher. The TED spread remains rather wide which might signal a continued tight credit market. The two year Treasury note has increased to around 2.2% which is approximately the Fed Funds rate. This might signal a more bullish market trend. It seems the economic fundamentals are quite negative, minus the large increase in the money supply. How does all this fit with your continued prediction of a ~35% drop in the S&P and what are your estimates on the timing of the correction/crash?

Dan said...

The worst is over - the bottom is in

John said...

I want to be bearish but I think we are running out of excuses to do so. This rally finally closed above 1396, a higher reaction high for the S&P. I think that is a significant buy signal for most. The rallying on bad news has been concerning. If we rally on a negative GDP # that will be enough for me. I think the bear may need to sleep till '09. All the charts look really bullish.

John said...

do I detect sarcasm?
I will be watching the GDP number very closely next week. I think anthing < -.1 will send the S&P down a bit but > -.1 will result in dancing in the street (Wall Street that is). The inflation number is the same way. Expectations are so low that almost nothing can send the markets significantly lower. The real question is "when is the correction coming"? I think the fundamentals are too negative to not eventually play out. Here is a line I heard, "positive spin on 0% GDP is like saying a 103F temperature is good compared to 105F. But 103 is still really sick". Consumer debt as a % of GDP has grown exponentially over the past decade, govt debt has grown but is near the long term norm as a % of GDP. Consumer lending has tightened and real income is falling. GDP has been "overstated" due to the high level of borrowing. We know that GDP doesn't measure "net worth". So debt/ leveraging can inflate the GDP significantly while "net worth" is declining. Anyone concerned about Medicare/Medicaid or SS? So, I ride the bull up a bit but when do I get out. I am in Jody's camp, long term prediction of S&P at ~8500. I may be a bit more optimistic on the bottom, S&P ~10000. Any thoughts (supported by data/ historical trends)?

Jody said...

Bottom line: I remain long-term bearish. The yield of the S&P 500 is still too low, (2.1% instead of 3% to 6%) and the projected as-reported P/E ratio for the S&P keeps being revised downwards. Right now the forward P/E ratio is 19.3 for the 4th quarter of 2009.

John said...

Jody, Glad you’re sticking to your convictions. Did you notice the rising wedge on the S&P? I think it closed at today’s high. Tomorrow should be very interesting.

Jody said...

Oops. I meant to say the P/E ratio is being revised upwards, because earnings are being revised downwards.

john said...

I had to look hard for this but remember reading some analysis to your PE point. This guy called the low and the reaction rally.

As a forward pricing mechanism the equity markets typically carry higher PE multiples during recessions. In 1991, the S&P 500 quarterly operating PE ratio was in the 17-21 area. In 2001-2002, the S&P 500 quarterly PE ratio was in the 18-29 area.

This analysis suggests that the downside of an impending bear market for the S&P 500 is nowhere near the magnitude of the 2000-2003 bear market. Further, it suggests that the S&P 500 may already have priced in a significant portion of the recessionary expectation.

Jody said...

I use "as reported" earnings in my analysis, not operating earnings, which tend to be overly optimistic.

The trailing as-reported P/E ratio of the S&P was between 7 and 15 for several multi-year periods: 1940-1945, 1947-1958, and 1973-1986. In between these low-P/E periods, there were several P/E peaks near or above 20 that were followed by crashes or bear markets: 1946, 1961, 1966, 1973, 1987, 1998, and of course 2000.

The 17 year period since 1991 has been an anomaly, because the as-reported trailing P/E ratio has never fallen below 15 in that time. I think it is unwise to look at the data since 1991 and assume that the market will continue to behave that way. If anything, I'd say we're well overdue for the P/E ratio to fall back below 15.