Yahoo! Finance is currently headlining: “Don’t Fight the Rally: Stocks Soar After Europe Deal, Dow Clears 12,000.”
Is that a top-ticking headline? Let’s investigate.
The 5-year chart of the S&P 500 below from Yahoo! Finance shows that stocks may be at an important turning point in either direction. Here’s the chart, with discussion to follow.
To date, the 2011 stock market has tracked that of 2010 amazingly closely, with a month or two delay. An early rise, a spring peak, a traditional summer-early fall bottom, then off to the races. In that scenario, a moderate decline would continue to track 2011 by completing a “head and shoulders” bottoming process. That scenario in general rests on the Fed’s (and therefore the mainstream’s) forecast of no new recession either underway or beginning early in 2012.
Now please direct your attention on the chart to 2008, which I submit has begun to recede in traders’ memory as we all tire of talk of another year of poor economic news. 2008 began with a fall, which was triggered first by a huge loss at SocGen and then which bottomed with the bailout of Bear Stearns. That rally to just above 1400 that peaked in May was based on the analogy that the worst was over. The general view of the supposedly all-knowing markets was that tax rebates that were underway and the proactive wise actions of the authorities in dealing with Bear would keep any recession- the existence of which was highly uncertain- mild. Thus, a recession had been “priced in”. When Fannie and Freddie successfully marketed securities in the U. S. and internationally in the summer and an “anti-recession” housing bill had occurred, a secondary peak occurred in mid-August around 1300. Even after it was revealed that whatever reps and warranties Fannie and Freddie may have made just a few weeks earlier when they sold securities were inoperative due to the gross insolvency of those enterprises being “suddenly” discovered, there was yet another brief rally to around 1255 in mid-September. By then there was no doubt that a recession was underway. We know what happened next.
It was not only stocks. The price of oil kept going its merry way, rocketing upward to nearly $150/barrel by mid-year 2008 before collapsing an amazing 75% or so in a mere half-year, far eclipsing the drop in stocks or gold. What wisdom did the rallying oil price have in 2008?
In comparing today to 2008, I would direct you to the following links that show the moving averages in May 2008 versus today. The S&P 500 today is in a similar position to its moving averages to where it was after the Bear Stearns rescue and the relief rally that the economy had dodged another bullet and that it was time to accentuate the positive again.
The 2011 chart looks more like the spring 2008 chart than it does the 2010 chart. Now as in 2008, the moving averages are in traditional bear market alignment, with the 50 day simple moving average (sma) below the 150 day, which in turn is below the 200 day sma. The 150 and 200 day sma’s are declining. That they are declining is absolute proof that a trend has been established. While trends are made to be broken, the 2008 example and many others suggest that if the consensus is far too optimistic about upcoming corporate profits, stock rallies such as the current one are rallies in a bear market. Rallies in a perceived bear market provide good exit points from stocks, which so often come back to these sorts of breakout points should the rally prove to be “for real” and markets surge yet higher as good economic and financial news swamps the bad.
Which way the economies and markets? My sense is that the stock market is over-optimistic. A straw in the wind is that an important body has declared Europe to probably already be in recession. From the Institute for International Finance (a bank group):
October 2011 Global Economic Monitor
We have trimmed our already meager GDP growth forecast for the Euro Area in coming quarters, and now project a mild recession in the region. The main factor shaping this recession dynamic is the tightening in regional financial conditions now underway as a result of the recent flare up in the sovereign debt crisis. One issue is whether Euro turmoil is enough to spread recession globally. A collapse of the system undoubtedly would, but this is not our forecast. The current situation seems similar to the early 1990s, when the EMS crisis in Europe led to recession there which hindered, rather than derailed, the global recovery.
If this is news to you, why is it news? Why has it not gotten publicity in the financial press? Also, consider also that this statement ignores the fact that the U. S. suffered a moderately serious recession at the same time as Europe two decades ago. (As did Australia and numerous other countries.)
In any case, my sense is that the recency bias of investors is that buying the dips is back. It worked during the corrections in mid-2009 and in every subsequent dip. Price-earnings ratios are comfortably low based on consensus 2012 corporate earnings, D. C. politicians are proposing to narrow the deficit, and our long national nightmare is over. At least so it is felt. Even the horrible, deep recessionary readings on numerous polls of public economic health can be spun as part of the bottoming process.
An alternative point of view is that the SocGen “rogue trader” giant loss of January 2008 is analogous to the UBS “rogue trader” recent loss, the bailouts and “stick saves” of Bear Stearns, the housing market and Fannie/Freddie in spring-summer 2008 are analogous to all the Dexia/Greece/etc. stuff goings-on in Europe, and the actions of businesspeople and the capital and inventory flows that are part of the business cycle (far) outweigh various governmental structures, accounting maneuvers regarding Greek debt and so forth.
What do I know that “the market” doesn’t, but my sense is that bears currently have the better arguments. The euphoria over the latest maneuvering in Europe seems faux to me. What has actually happened is that the Europeans have officially recognized that Greece is more insolvent than they were willing to declare it just a few months ago. Meanwhile I will guess that economic fundamentals throughout Europe have enough downside risk that a drip-drip-drip of bad news will start to erode that euphoria and has a good chance of turning to despair again.
My view of the U. S. stock market is simple. Any stock market in which Amazon.com can have one earnings “miss” after another and continue to carry a 100X p/e, with very little in the way of net cash in the bank or tangible book value relative to its market value is one that is dangerous. There is just too much hopium, in my view. In early August, I offered up a couple of blog posts after stocks had crashed proffering mild bullishness on the hope that we had seen the bottom a la 2010. I reversed that view after some rebound and after more evidence of recession rather than “soft patch” had appeared. At this juncture, stocks look both fundamentally richly-priced and technically overbought in the short term. This is also true for oil and copper, which after their recent rallies now have large downside risk should a U. S. recession in fact be recognized.
The Daily Capitalist remains on the case, perma-realistic as always.