Little did I know when I wrote on March 8th that a bottom might be in how correct that would turn out to be. Nine days later, with the market up almost 17%, I shared my views that the most likely scenario was that we are in a bear market rally that will be followed by a range trade. This action is roughly what I had anticipated back in January when I shared my expectations for stocks for the year. My best guess at the time (and still) was that the top of the range would be 860-920 on the S&P 500, with a single point estimate of 880, which would represent at 33% retracement of the move from August peak to the March lows. At the time, though, I certainly wasn't expecting the market to almost double that March spike so rapidly. The move from the intra-day low of 666 and change to Friday's high of 875 of over 31% represents one of the most powerful moves over such a short span of time ever.
While clearly I was wrong about the likelihood of a near-term pullback in the context of establishing a range for Q2, I expect that we will soon test this market. As I write, the pre-market indication is that this Monday will be similar to several other Mondays of late, with some opening weakness. While it could reverse and move towards my 880 single-point peak estimate or perhaps a little higher in the "860-920" zone, it would prove much healthier for the market to backfill. In fact, the rapid run-up, which may encourage others, gives me less confidence that the market can work sideways for the balance of the quarter. At this point, rather than the "730-750" low-end of the range I had expected, I will be concerned if we were to break 790. In fact, I would probably question the rally before then, as a break of 797 would send us negative on the quarter.
So, why has the market rallied so darn much? While I am certainly sympathetic to the notion that a lot of this move has been due to manipulation by the government on several fronts (mark-to-market accounting changes, talking the market up, etc.), the more likely scenario is that market participants realized that the wheels weren't falling off the car. Cash had built up to very high levels after what had to be one of history's worst two-month starts to the year ever. While it wasn't mathematically possible for the economy to continue to decline at the same rate on a sequential basis, folks were scared nonetheless. As we have progressed through half of earnings season and a few more macroeconomic reports over the past six weeks, I guess people have decided that the tank is half-full and not half-empty.
For those who think the ultimate lows were made in March, I believe their views are way too optimistic. In that article where I suggested that the temporary lows could be in, I shared a few markers I expected we would see along the way to the real recovery:
Over the past few months, as we have gotten by definition closer to the bottom both in time and in level, I have gained further clarity regarding how to tell that the economy is at a bottom, and it isn't anytime soon. I have identified three major signs to look for when anticipating an end to this depression:
- Home prices will actually be cheap compared to median incomes (overshoot)
- Savings rates will be approaching 10%
- Debt to Asset levels will be lower in general for companies and significantly lower for Financial companies
It's really that simple and all about deleveraging, but it takes time and will look very ugly along the way. I am sure that there are other milestones, but these are certainly among them. Even when the bottom is in for the economy, the higher tax burden to pay for the "rescue" and continued consumer aversion to spending (is that possible in America?) will constrain growth for years to come most likely.
Stocks were too pessimistic at the time, but are now at best fair and probably optimistic. Has anyone noticed lately that short-term corporates broadly yield in excess of 4.5%? Stunningly, demand for corporate bonds is actually off-the-charts, yet the spread to short-term Treasuries still remains at levels unseen in my 44 years. As far as housing goes, the recent stabilization of volume is on the back of all-time low rates, plunging prices and a government subsidy that has pulled in some pent-up demand from first-time home purchasers. This is not the stuff of a sustainable upturn. While it is true that housing may not be the extreme drag that it has been, I expect that this spring fling will prove to be a summer bummer.
So, I am not confusing this repricing of stocks as a sign of a change in our general economic direction. This was all about investors remembering that investing is actually a two-way street! To continue the car analogies, our economy is like the used automobiles of a certain age that merit the potential $5000 clunker payments. The government is spending and spending our future (because they MUST) to keep the economy from continuing to implode. It is overpaying for all sorts of economic activity in order to "stimulate". Until we see signs of the economy driving on its own instead of behind a tow truck (anyone have a good graphic to insert here?), I won't be sucked in.
Disclosure: No stocks mentioned
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