By
Chris Ciovacco
February 25, 2009
Tuesday's Big Gains Lacked Upside Volume:
Trends can help us understand the collective
perceptions of investors, which ultimately
drive asset prices (see charts below).
Fundamental Changes Not
Behind Tuesday’s Rally: What appeared to
have sparked yesterday’s rally?
- Ben Bernanke on Economy:
"If actions taken by the administration,
the Congress and the Federal Reserve are
successful in restoring some measure of
financial stability -- and only if that
is the case, in my view -- there is a
reasonable prospect that the current
recession will end in 2009".
- Bernanke on Banks: "We
don’t need majority ownership to work
with the banks." This appears to
mean we will have slow and partial
nationalization of the banks instead of
"full" nationalization. Either way, it
dilutes the current stockholders and
means the U.S. government, either
directly or indirectly, will have major
influence and power over the banking
system. Based on the government's track
record of running anything (e.g.,
Medicare, Social Security, Federal
budget, Fannie Mae, the Fed, etc.), it
is difficult to see these devlopments as
a positive for the economy, free
markets, or investors. The government
has been "assisting" banks for roughly a
year now. Has it really helped? So far
the bailouts are reminiscent of "zombie
banks" and Japan’s "lost decade". How
long will the government be in the
banking business? Our guess is a lot
longer than most people think.
- Valuations: Lower valuations
do not guarantee a market bottom as pure
value investors have found numerous
times over the last year. If we use very
reasonable normalized earnings and PE
multiples found at the 1974-1975 bear
market bottom, the S&P 500 could
realistically fall to around 525 before
the market bottoms. If you are buying
solely because the market is "cheap" or
"near a bottom", keep in mind the 525
figure is based on actual historical
valuations. We are not forecasting
525 on the S&P 500. We are just
trying to understand how low valuations
may get before investors feel compelled
to step in and buy. To reach "worst-case
bear market bottom valuations" the S&P
500 would need to fall 32% from
Tuesday’s close. If you lose 32%, you
will need to make 47% just to be back to
break even. For example, if you hold
between 768 and 525 on the S&P 500, you
will lose 31.6%. A 31.6% loss on
$100,000 would leave you with $68,400.
If you gain 47% on $68,400, you would
earn $32,148. $68,400 + $32,148 =
$100,548 (back to break even).
- Range Traders: Range traders
are just that "traders". They are not
long-term investors. They try to profit
from buying at the low end of a trading
range and selling at the top of the
range. Stocks are at the low end of a
trading range that began in October
2008. Range traders may have no
intention of holding for the long-term,
which means their buying pressure will
be converted to selling pressure in the
future. Yesterday’s volume looks like
bargain hunting and range traders
stepping in – it does not look like the
beginning of a new bull market. Could
stocks rally from here? Yes. Could
yesterday have been the end of the bear
market? Not likely, but if we see
observable evidence to signal a
significant change in trend, then we
will consider putting more capital at
risk. We need to see more. We need to
remain patient for now. If you waited
for clear signs of a trend change after
the 2000-2003 bear market, you would
have invested more aggressively (and
with more confidence between May 1, 2003
and May 14, 2003). The S&P 500 still
increased roughly 69% from the May 14th
closing price to the bull market high in
2007 - a great return with a good
risk/reward profile (much better than
today's risk/reward profile). Since we
sold early and protected our principal,
we have the luxury of being patient.
Even if you did not sell early, we
remain in a bear market and protecting
principal is still very important as
illustrated by the 32% loss / 47% gain
example above.
The charts below put some
context around yesterday's moves in both
stocks and gold. How a long-term investor
and a trader interpret yesterday's moves may
be quite different. For investors, gold
still looks attractive and stocks remain
unattractive.
Volume can help us better
understand investor's demand for or
confidence in stocks. When investors are
confident, stock market gains occur on
strong volume.
If you scroll down to the
section 2008 - Monday's Gains - The Bad
News: Weak Volume in the October 13,
2008 article
Bear Markets Tend To Retest Lows, you
can see volume on SPY (S&P 500 ETF) at
2000-2002 bear market lows. Compare the
chart of SPY (2000-2002) to the chart of SPY
above focusing on trading volume.
Strong volume could still
come, but it did not occur yesterday in a
manner that is similar to lasting market
turns. In the up/down volume figures above
(see red box), we would like to see
something in the 90% / 10% range rather than
the 79% / 20% that we saw yesterday.
Detailed research conducted by Lowery’s
Reports over the last 76 years of market
history supports the 90% / 10% comment
above. At a bear market bottom, we need to
see powerful demand for stocks.
Gold Had A Bad Day:
One day does not make a trend. Tuesday's
pullback does nothing to damage the uptrend
off the October 2008 low. Volume on GLD and
GDX are somewhat high which is a little bit
of a concern, but it is not surprising to
see a sharp retracement after a good run.
Investors should manage gold as we would any
other investment, which includes monitoring
gains and losses and protecting capital when
needed.
AIG Back To Uncle Sam’s
Well – From Reuters:
NEW YORK - American International Group,
rescued twice last year by the U.S.
government, is asking for more aid and
bracing for a fourth-quarter loss of
roughly $60 billion, a source familiar
with the matter said. It would be the
biggest loss in a quarter in corporate
history.
FDIC Sees More Trouble
Ahead: Monday’s Wall Street Journal
reported FDIC officials are "pushing
Congress to raise the amount of money the
agency can borrow from Treasury to $100
billion, more than triple its current
limit". If the FDIC thought we were on the
cusp of an economic and housing turn, they
would not be lobbying so hard for new funds.
The FDIC knows banks have much more pain in
their future.
Housing Prices and
Banks Will Continue To Be Under Pressure:
Stock futures are higher in Monday’s
premarket on more government bailout news –
once again related to Citigroup. This
bailout, as with many before it, does not
directly address the fundamental problem
with housing – too much inventory. As we
have mentioned on numerous occasions, no
government bailout or mortgage program can
alter the natural laws of supply and demand.
Using the pace of sales in December 2008, it
would take 12.9 months to sell all the new
homes currently in inventory. We need to get
down to five or six months of inventory
before we can expect to see prices
stabilize. A glut of supply means home
prices will remain under pressure. Falling
home prices means more problems for banks.
Mark Zandi, chief economist at Moody’s
Economy.com, estimates that even with the
new Obama foreclosure reduction plan, the
United States will see 3.1 million
foreclosures in 2009. We had a record 2.7
million in 2008. Home prices will continue
to be a problem. Foreclosures will continue
to be a problem. Banks will continue to be a
problem. Despite this weeks’s hope of
another lifeline for comatose Citigroup, the
fundamental problems with our economy
remain.
Citigroup – Third
Bailout A Charm? The Wall Street Journal
reported on Sunday night the U.S. government
is in talks with Citigroup to
"substantially" expand its ownership of the
poorly managed bank. The new deal could
result in taxpayers owning up to 40% of
Citigroup. With new government bailouts
coming at dizzying rates, it is easy to lose
track of how much the Feds have already
committed to Citigroup. To refresh your
memory:
- October 2008: The Treasury
Department gave $25 billion to Citigroup
- November 2008: $20 billion
more was given to Citigroup
- November 2008: The government
agreed to protect Citigroup from losses
on $301 billion in assets.
The sum of the
government’s backing of Citigroup to date
comes to roughly $346 billion. Has it
worked? Below is a chart of Citigroup stock
since October 1, 2008. The market has not
been impressed.
More details on
nationalization can be found in this
Bloomberg article,
Obama Bank Nationalization Is Focus of
Speculation
Chris Ciovacco
Ciovacco Capital Management
Chris Ciovacco is the
Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at
www.ciovaccocapital.com
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however, CCM makes any representation as to,
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