I'm writing this Thursday evening, after the wildest day in the stock market since the craziness of 2008 and early 2009. To me, the worst of the volatility late in the day had all the signs of a technical situation -- some kind of error in some trading system somewhere. As of Friday afternoon, we still don’t know the truth.
But that doesn't explain why stocks were down so much before whatever caused that late-day oscillation. And it doesn't explain why, when whatever it was happened, stocks were so vulnerable to it.
That's simple. Stocks were way overbought. They were ready for a correction, and a nasty one. We got it.
Or perhaps I should say we finally got it. I don't want to be one of those guys who claims victory when something happens that he's been predicting for so long that he comes off like a broken clock being right twice a day. That said, to some extent that's the nature of the beast. When you make a call that stocks, broadly speaking, have risen too far, too fast, and are due for a correction, that kind of statement inherently doesn't have a lot of timing precision to it.
The reality is that from the bottom in March 2009 to the highs late last month, stocks had the best run since 1935, and the sixth best run in the recorded history of daily U.S. stock prices. It doesn't take a genius to figure out that's not sustainable.
There were a lot of good reasons for stocks having risen as they did. First, we came from a terrible panic in March, 2009, when they were deeply oversold. Then as the rally progressed, it was fueled by a huge increase if corporate earnings, as the economy came out of deep recession.
But all these things are cyclical. At the lows, earnings were depressed, and prices were depressed even more, so the price/earnings ratio for the S&P 500 was about 10. That's about as low as it gets . There have been times when it as lower, but that's about where it was at the worst in the Great Depression.
At the highs in late April, the price/earnings ratio had risen to about 15. That's about as high as it gets. Sure, it got higher in the crazy years in the late 1990s. And there have been other exceptions. But that's about where it was at the highs in October 2007. So what we've seen was simply running from the low bound of the p/e ratio to the high bound; a classic cycle.
None of this means that the economy is heading back into a recession. But it should take some wind out of the sails of the most optimistic who thought that an endless upward run in stocks indicated a "V-shaped recovery." No, it's going to be a little slower going than that.
After the severe global credit crisis we had in 2008 and 2009, the economy doesn't just spring back to normal. You can't put Humpty Dumpty together again. You have to lay a whole new egg.
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Stocks Slide -- It's About Time (Ahead of the Curve) http://bit.ly/cszPmU via http://topicfire.com/Business
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