The stock market peaked April 26th and in the ensuing month, roughly 12% was erased from the value of the S&P 500. There is no telling how many years were collectively removed from the lives of investors due to heart damage from fear of a repeat of late 2008 but if the VIX is any indication we might have reduced the long term cost of healthcare reform last week. That all this fear could be generated from a debt crisis in an economically irrelevant backwater of Europe is nothing short of amazing.
Corrections are always difficult to navigate but the relative proximity of this one to the panic of 2008 makes it even more anxiety ridden. How do you know it’s a correction and not a resumption of the bear market? Well, if this correction has you biting your nails at least take comfort in the fact that it is perfectly normal human behavior. In psychology it’s called recency bias; we impart more importance to more recent events. Obviously the most recent traumatic event for investors was the crash of 2008 and so any correction brings back those memories and for a lot of people the mere memory was enough to get them to sell.
It probably isn’t coincidence either that this correction started at roughly the same point where the market really started to melt down in the fall of 2008. The 1200 level on the S&P 500 was the last point where you could have sold and avoided the crash portion of that crazy year. If you missed that opportunity to sell on the way down and held all the way through to get back to where you were, it is very tempting to just get out and avoid even the possibility of replaying that horror show. And obviously a lot of people exercised that prerogative in the last couple of weeks. Was it a wise decision? Only time will tell but the track record of decisions made out of fear isn’t a good one.
The VIX rallied into the 40s last week, a level it rarely visits. In looking over the last 20 years, I can only find 5 instances where the VIX got to this extreme level and in every case, it turned out to be at least a short term buying opportunity if not something more significant. That doesn’t mean that a rally has to start right now but generally when volatility gets that high you’ve reached some kind of inflection point. The last three times we breached 40 prior to 2008 was during the Russian Ruble crisis in 1998, right after 9/11 and when the market was bottoming out in the summer of 2002. All were pretty good buying points. Will this one be as good? I have my doubts about that but I do feel comfortable saying that this isn’t a rerun of 2008 when the VIX managed to peak at nearly 90.
So anyway, back to irrelevant economic backwaters. I warned recently that the US economic recovery was hitting its maximum rate of change and that investors should tread carefully in the coming months (see Zone of Uncertainty and As Good as it Gets? for example). The US recovery has been primarily a function of monetary stimulus and with the Fed actively discussing its exit strategy it is not surprising that doubts about the recovery are creeping into the market. Personally I think this correction had a lot more to do with the possibility that the economic recovery is peaking than the fallout from the Greece debt crisis. As evidence, consider the state of another debt “crisis” that was mostly resolved last week with little fanfare. You might not remember it now but back in November another small country with a big debt problem was hogging the headlines - Dubai.
Well last week Dubai World, the government owned conglomerate that was at the middle of the crisis, reached an agreement with its creditors. The restructuring requires creditors to extend maturities and the government of Dubai to convert some debt to equity. Dubai World’s debt will be reduced by about 40%. And therein lies a lesson for Europe and Greece. The way to solve a debt problem is to reduce the debt not lend more. The reason the shock and awe campaign didn’t work as planned is that it isn’t credible. Lending Greece money in exchange for some spending cuts and tax increases only moves the problem down the road a bit when it will be an even bigger problem. Somebody who owns Greek debt is going to have to take a haircut before the market takes anyone in Europe seriously.
As for US markets, the correction has restored some value and while I’m still wary of the economy, I do feel a lot more comfortable putting money to work at these levels. In my last few commentaries I’ve stated a preference for real assets and while commodities took it on the chin even worse than stocks in this correction, my opinion hasn’t changed. The likely response to what is going on in Europe as well as any slowdown in the US will be further monetary easing in some form or fashion. With the official inflation numbers coming in less than expected last week, the Fed will feel comfortable continuing to put off the execution of any exit strategy. Meanwhile the ECB will be severely tested over the coming months and I fully expect them to succumb to political pressure and find a way to justify further easing. To me that means commodities will resume their rise. It might also mean it is time to start digging through the debris in European markets; European multinationals that get a lot of their revenue from outside Europe might be very interesting investments at this point.
The US economy still faces some significant hurdles over the coming months but for now the economic recovery continues. It isn’t as robust as we’d like of course - it never is - but it does continue. While the peak rate of change may have already been seen that doesn’t mean we are headed for a double dip and a resumption of the bear market. The more likely outcome is slow growth, continued high unemployment and eventually higher inflation. That isn’t great but it isn’t disaster either at least if you aren’t an incumbent politician. For once it is the politicians who have something to fear.
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Technical damage last week was signficant but not fatal to the bull case. Look for a bounce to the 1150 area in the short term. Breaking the 200 day MA is a warning sign but does not mean a bear market is imminent. We broke that level 5 times in the last bull run from 2003 to 2007. More likely is a period consolidation.
The uptrend in gold is intact even after a minor correction.
Assuming we aren't headed for another deflation scare a la late 2008, this should be the bottom on 10 year Treasury yields.
If the panic out of risk assets is over then the yen rally is too. Long term fundamentals would seem to favor a lower yen.
Let’s look at some individual stocks that still have positive charts:
Even after a big hit in the correction Owens Corning is still above its 50 day MA and in an uptrend.
Navistar's uptrend wasn't dented by the correction.
Hitachi
No correction at Family Dollar.
And some things that are deeply depressed but may be making bottoms:
Banco Santander is about as contrarian a play as you can find. Looks to me like it made a higher low.
Considering its in Europe, Daimler's chart doesn't look bad.
Kimberly Clark
Barclay's may be a beneficiary of US financial reform.
Crazy month for the currencies:
Index 21-Apr Last Price % Gain USD/Euro 0.75 0.80 6.13% USD/British Pound 0.65 0.69 6.46% USD/Japanese Yen 93.13 90.00 -3.36% USD/Australian Dollar 1.08 1.20 11.20% USD/Brazilian Real 1.75 1.87 6.80% Gold 112.41 115.30 2.57%
© 2008-2009 A.I. Research. All rights reserved.
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