Tuesday, February 24, 2009

Nice Bounce, But the Dow Is Headed to 5237

Tuesday was get even day for the bulls, wiping out most of Monday's losses, almost as though they never happened. But they did, as we know, with the Dow, S&P and NYSE Composite all breaking below support and hitting new lows.

So, while Tuesday will likely go down in the books as a simple snap-back rally, Monday was the more portentous of the two days, and we are now sure as shootin' going back to the 7100 level, though just when that happens is an open question.

Dow 7,350.94, +236.16 (3.32%)
NASDAQ 1,441.83, +54.11 (3.90%)
S&P 500 773.14, +29.81 (4.01%)
NYSE Composite 4,821.73, +187.95 (4.06%)

The likelihood of a rally is very good here, as the market was technically oversold. There are still speculators with cash in hand, dying to jump in and today was one such day. Their hopes of quick, easy money will be soon dashed. It took three months to retrace back to the November 20 lows, so surely a 2-4 month time span is surely appropriate for a revisit to 7114.78, yesterday's close.

For the rest of this week, though, and into next - prior to the Friday, March 6 BLS Non-farm Labor report - prospects are reasonably good for gains.

We've entered a period of the recession and bear market that may prove difficult to track and predict. Major indices have taken half off their 2007 peaks, so further deterioration should be slower and more agonizing. We could witness a period of sideways action for some months, but an eventual, final purge is needed and we haven't gotten to such capitulation yet. That could come in 6 weeks or 9 months. It's up to the markets and highly dependent on how well the government handles the crisis, which, up to this point, hasn't been very promising.

Fed Chairman, Ben Bernanke, testifying before congress today, said, "it is reasonable to expect the recession to end this year." Should we believe him? Maybe, maybe not. Recall, this is the same man who said that the subprime problem was "contained" back in the first quarter of 2008, so we know that his powers of prediction and grasp of the situation are less than accurate. Furthermore, he's presided over the worst economic catastrophe since the 30s, and as of yet his solutions haven't produced any positive developments. Still, even a broken clock is right twice a day, so, by calling for an end of the recession in 10 month's time, the erstwhile chairman has provided himself plenty of room for error.

Yesterday, I postulated that this recession, being larger and far different than anything other than the Great Depression, is going to last longer and plunge the US economy deeper than the others, which generally last 16-24 months. I am still looking at a horizon of 27-30 months duration, which puts recovery off until January 2010 at the earliest and June 2010 at the latest, using September through December 2007 as the actual start of the recession.

So, where's the bottom? I ran some calculations, using a fairly simplistic - but I believe sound - formula: comparing the price of the Dow Jones Industrials to the annual growth rate of US GDP.

I found an excellent site for tracking GDP growth rates by region and country back to 1961, here.

Using 1992 as a baseline, annual GDP growth over 17 years (1992-2008) came to 2.94%. Then, using the same baseline for the Dow, I calculated that 2.94% growth on top of the Dow at 3200 (an average closing price from January-March 1992, a very stable period). The result was 5237. Mark that number down, because that's where the Dow is headed.

To get an idea of just how overinflated the Dow (and stocks in general) had become from 2005-2008, consider that starting at 3200 in 1992, the Dow grew by more than 9% per year over that 17-year span. It's simply not believable, rational or normal for stocks to advance at such an exceptional rate. 2-5% is more like it, and that's why - back in the good old days before 1980 - investors sought out stocks more for their dividend yields than their growth potential.

Obviously, the internet and the coming of age of baby boomers brought in a gaggle of rubes who knew little about investing, and the market now has rewarded them justly by eviscerating most of their money. The market is probably going to take a little more before it's done.

One can argue that my analysis is too cursory, arbitrary and that it doesn't account for inflation or dividends, and to that I say, well, do your own analysis, please! I encourage all investors to analyze, slice and dice and dissect the markets for price discovery. There are many methods, and I believe mine will prove as sound as any. I'll state right here and now that I'll be within 400 points of the eventual, true bottom, and I'll accurately predict the market bottom to occur between August and November of this year. (Hey, it's only my reputation at risk here.)

Getting back to Tuesday's issues, besides Bernanke blathering at the insipid senators and lethargic legislators, the S&P/Case-Shiller Home Price Index dropped 18.55% in the 4th quarter of 2008 from the same period in 2007. Nationally, home prices are down 23% since their mid-2006 peak, suggesting that the decline is far from over.

Between the stimulus plan, bank bailout and foreclosure plan forwarded by the president and congress over the past few weeks, the housing market should bottom out by this time next year, with a total national decline of 34-38%, though many homes in what were once the hottest markets could fall by 50% or more.

Consumer confidence checked in today with a record low reading of 25.0, The Conference Board reported.

On the day, advancers finally held the edge over declining issues, 5271-1401. New lows continued ahead of new highs, 736-9. Volume was very strong, a function both of pent-up demand and furious short-covering.

NYSE Volume 1,841,785,000
NASDAQ Volume 2,371,004,000

Commodities were once again mixed. Crude oil futures finished $1.52 higher, at $39.96. Precious metals continued to be hit by a profit-taking wave, as gold pushed lower by $25.50, to $969.50. Silver presented investors with a buying opportunity, down 46 cents, to 14.00.

As mentioned before, gold and silver still look attractive at current levels and they will present buying opportunity over the next few weeks and months. Stocks are still risky, though if you are day-trading, good gains are possible for quick-turn artists.

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