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Today's Market WrapUp 02.26.2009 Mon Tue Wed Thu Fri Park Archive Is the Market Glass Half Empty or Smashed Into Oblivion? Investor sentiment hit a fresh low this month. Global fear is palpable. So many have been so decimated in this ongoing downturn, few highlight hope for recovery. Delirious euphoria of 2007 has transformed into unanimous despair in 2009. Those that called market bottoms week after week as the market fell are now declaring this contraction bottomless. Billionaires are jumping in front of trains. Previously celebrated money managers are being handcuffed and indicted. Dow theorist E. George Schaefer’s 50% Principle theory warns of potential doomsday. The Dow’s February 20 close of 7466 now risks a retrace of the entire gains made by this index since 1982. The Dow could be back at 776 some time ahead? It seems this horror show will never end; the black appears ubiquitous. The last time I remember such tangible global anxiety was in late 2002. The tech bubble had burst. The twin towers had fallen. Anthrax was in the mail. SARS was traversing the globe. World markets had imploded by half. The SEC was investigating: CEO’s, investment bankers, brokers and insiders. Lawsuits were flying. CNN broadcast terrorist alerts night and day. People were too afraid to fly on planes. Wars in Afghanistan and Iraq had just begun. I recall staying in a hotel in downtown Toronto about this time, staring at the CN Tower looming out my hotel window one night and thinking that if terrorists were to blow the Tower, it would very likely crash through my hotel and vaporise me in my bed. I briefly thought of changing rooms. I then deemed it pointless as the entire hotel would undoubtedly implode. I drifted off to sleep anyway. In the weeks ahead, the news grew bleaker. The jobless recovery began all the same; just when it was least predicted. As the expansion ran on, I became increasingly concerned about reckless credit expansion creating unsustainable demand. By late 2005 objective risk metrics were headed off our charts. By early 2007, to my amazement our technical measurements recommended virtually complete risk aversion. From 2006 to late 2007, it was hard to find anyone as worried as me about the high probability of an imminent bear market. As it turned out, our fears were a little early. A few clients fired my management firm for being “too conservative” with their money in 2007. But sticking to our rules by early 2008 we were completely out of equities and high yield bonds. Owning only Canadian and US dollars, government bonds and cash, we were able to gain nicely throughout 2008. As I compare the fears today with those in 2002, I think some are worse, some are not. Certainly the world has more debt today than it did 7 years ago. More people have negative equity in their homes today than they did in 2002. This recession has been in motion for 15 months, already a year longer than the then 3-month contraction. This downturn is deeper and longer, and it is not finished yet. But I must offer here a timid and wildly unpopular thought: surely there is less price risk in equity markets today than at any time in the past 15 years. Let’s look closely at this monthly chart of the S&P 500 price action since 1994.
Note that the Relative Strength (RSI) readings at the top of this chart were incredibly overbought--well over 70 on a monthly basis around the market peaks in both the late ‘90’s and 2006-2007. (This was one of the indicators which had us feeling bearish back then.) Now let’s note that this same indicator is presently the most oversold ever in the past 15 years, with a reading of less than 20! (See the circled area at the top far right.) Even in the depths of the 2002 Bear, the oversold RSI bottomed out around 30. A lay person can think of it this way. The probability of further market gains when the RSI is at 80 are about 20%, with the inverse 80% probability of market declines. With the RSI at 18.8, there is an 18% remaining probability of further declines and 82% probability of a price rally. This is not how technicians might explain this indicator, but the analogy is still useful. Before rabid bears tear at my flesh, I am compelled to offer up the following bullish thoughts that seem presently overlooked:
The sky is still very cloudy, but will it fall? Opportunities are doubtlessly emerging all around for those not too shell-shocked to come out of the bunkers and rummage around. We have started some careful buying of high yielding equities and corporate bonds. Yes we still have a lot of cash. And yes we have pre-defined our sell rules. I would never advocate wild abandon. We will continue to monitor our technical measurements very carefully and we will sell again if another major market storm threatens our capital. This is no place for blind optimism. I never recommend that anyone passively buy and hold risk assets. We are likely to be in a range bound secular Bear market for the next few years. But all that said, beware of doomsday cults. Just as it was in 2002, the picture is always darkest before the dawn. The beginnings of a new cyclical bull are more likely to be in the offing now, than at any time in the past 15 years. Acknowledge the downside risks, devise an escape or hedge plan in case of emergency, but don’t ever forget to also look for the light. Danielle Park Copyright © 2008 All rights reserved. CONTACT
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