January 17th, 2009

The Inauguration and the Market.

When most people see into the future they usually merely extrapolate recent experience. Some, however, move to the next step in projecting the future and try to identify when and why the extrapolated trend will change (sort of like taking a contrarian view).

Most projections you see or hear today see the damage that’s already been done to the economy last year, especially during the fourth quarter (remember, the recession was said to have begun in December, 2007). They extrapolate into 2008 and see major bankruptcies in retail (Sears, Gap, Macy’s), banking, home construction and, even, in state, city and local governments. They see oil as having declined from $140 to $35 per barrel and can only see the price dropping to the $20’s (remember when oil as $140 and most saw it going to $200?).

It’s easy measuring what’s happened over the near-term past and seeing what a continuation of that trend might lead to over the near term future. For example, it’s relatively easy to see China’s pause after the Olympics and the slow-down it’s experiencing due to the global economic recession lead to continued and deeper recession there leading to social conflict and strife.

But what’s not easy to do, and quite risky I might add, is to see these trends turning and even reversing. If you’re selling something (like a financial newsletter or a political platform) it’s an easier if you appeal to people’s fears than if you appeal to their hopes. More of the same is more believable than something that doesn’t yet exist, can’t be described and can’t be experienced.

Take, for example, a recent Bloomberg article in which both John Murphy chief technical analyst of StockCharts.com and Ralph Acampora, a true guru of technical analysis say that they hope that the October lows will hold but, if they don’t, the Dow will decline further to 6000 (and the S&P 500 to 600, by inference). That’s where we are today in the market.

But I’m going to go out on the limb and say that I think we did hit a bottom and it will hold. Furthermore, I believe sometime before the end of 2009, the S&P 500 will have hit 1100 and be struggling to move solidly into a bull market, mark-up stage. On what do I base this speculation?

On a long-term market view I reported on October 11 in “The Magic Number is Actually 7.5% per Year”, [Confession time: the title actually said “8.12%” – it was either a typo or purely a calculation error to be corrected now!] In that post I included the chart I’ve updated below (please click on it to enlarge):

Back in October, I wrote:

A band of 44% above and below the regression mean bounds the Index throughout the period and contains the Bull Market of the 1950-60’s, the secular Bear Market of the 1970’s and the Bull Market of the early 1990’s (except for the tech bubble leading up to Y2K). Interestingly, all the Bull and Bear Markets prior to the Tech Bubble, grew at either the upper, lower or midpoint at the 7.5% rate.

Here’s what I all this means for us today? The good news is that after last week’s collapse, the Index came within 6% of the bottom boundary (intra-day 839 low vs. 789) boundary); we should be very near the bottom. The bad news is that projecting forward to the end of 2009, the lower boundary increases to only 858, or still below Friday’s close.

There will be bounces but, in all likelihood, it will be a long time (several years) before the Index touches 1400 again. Unfortunately, the “buy-and-holders” are going to feel extremely frustrated. Market timing will be extremely important. You’ll have to trade gingerly taking advantage of recovery moves. You’ll have to be patient and not expect a robust Bull Market to return anytime soon. Shed poor performing stocks and, as market weakness appears, become defensive to conserve your capital.

Those of you who’ve enlarged that charge can see that the lower boundary has moved up from 789 in October to 803 last Friday. Since the chart is based on month-end data, November’s intra-month low close of 752 would have been marginally below the lower boundary. But the market bounced back and Friday’s close of 850 is not more than 5.8% above the lower boundary.

Can the market decline back to that lower boundary? Perhaps. Will it break through? I think not. The only times it fell below that line were:

Granted this is a bad recession; some even call it the beginnings of a depression. It’s not only here but it’s worldwide. Has the market fully baked in the economic distress? Has the market adequately reflected the $trillions that has been created to stave off further effects? Will the market deviate from the mean more than the 9.98% of 1982 (making today’s low at least approximately 725)?

Without getting political, I thing that investor psychology (as well as that of the general populous) see’s the Inauguration as a new beginning and psychology is the other half of the market (economics being the first). Ronald Reagan took office in January 20, 1981 and the country sighed a deep sigh of relieve as Jimmy Carter left office leaving behind the high oil prices and high interest rates; the hostages were released in Iran that same afternoon. Barack Obama is being inaugurated and perhaps we’ll be as lucky.

Extrapolation is easy and safe. The risks and rewards are in seeing when and how things will be different.

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