July 17, 2008
- Tuesday was a near-capitulation type of sell-off. It is bullish for the stock market that the following day, Wednesday, bounced back so strongly.
- There is a danger that any likely rally from these levels could very well turn out to be a “sucker’s rally”, as we experienced a couple times in 1969, and more recently this April-May.
- The April-May rally earlier this year ultimately failed because of the law of supply vs. demand. In the latter weeks of the rally, prices advanced because supply (selling) decreased while demand (buying) did not pick up. A healthy rally is based on increased buying, not decreased selling.
- We are willing to sit out any potential rally at this point as we inspect the merits of any price advance. If prices move higher based on a resurgence of demand (i.e. buying), then we will feel more compelled to become involved with any momentum.
- Given that the election is close at hand (three-and-a-half months away), that also gives us pause in regards to jumping onto any rally from these levels. We will soon unlock the mysteries of what fiscal policies may dominate the economy for the next four years and, of course, that could heavily influence the types of investments we may wish to acquire.
Not only was Wednesday a great day for equity investors, but the day prior we saw the stock market get torn down to levels well below our projected 2008 Risk Level. In January 2008, we thought that the risk would be about 1,300 points on the S&P 500 – Tuesday we actually hit 1,200 points!
Given such a dramatic one-day rally from levels far below what we anticipated a half-year ago, we wanted to address whether or not we may have hit either “a” low, or “the” low.
I’m not trying to be overly subtle with semantics. “A” low can lead to a great rally that, unfortunately, fades away later – like in April-May of 1969, and like in April-May of 2008; like in July-August of 1969….and maybe like in July-August of 2008?
It’s that last question where we need to focus our attention – is this just “a” bottom, or is it “the” bottom, like the ones in October 2002 and October 1998, which both marked the beginning point of magnificent rallies.
In the beginning of the year we predicted a stock market bottom in the first one-third of the year as well as a subsequent stock market rally that would bring us all the way through the rest of the year and into 2009. So my ego would like nothing better than to look at the data and to see continued confirmation of that theme. That prediction may yet unfold, at least for the second half of the year, if not the final two-thirds. But we are a cautious bunch and do not yet have the guts to, for example, double-up on leveraged equity so as to take advantage of a new bull market. Strategically, we may wait until after the election to pull that proverbial trigger. Until then, we remain cautious.
So far this year, 2008 looks a lot like 1969, which was also a bear market year. In April-May of both 1969 and 2008 there were false stock market breakouts. In 1969, after following similar market action to that of 2008, stocks experience a similar false breakout that lasted from mid-July to early November. We are aware that while history does make it a point to repeat, it never seems to do so in exact detail (so expecting a repeat can do as much harm as good). But still, tracking these types of patterns often gives us some sort of perspective. The perspective we gain for these comparisons is that any stock market rally from these levels could, like the Bear Stearns Bottom, ultimately retrace back down to 1,200 on the S&P 500.
Moving past these visual comparisons, it will be important for us to see if any rally from these levels mimics the internals of the April-May 2008 rally (I don’t have internal information dating back to 1969 – yet).
During the April-May 2008 rally, the stock market initially saw a resurgence of demand (i.e. people started buying stocks), but in the later weeks prices advance more so due to a withdrawal of supply (i.e. people slowed their buying, but prices still went up because nobody was selling). The force of supply vs. demand is very powerful and should not be overlooked when pricing any good and/or service – including stocks.
Wednesday was a big and bullish day, with a huge amount of volume (6.5 billion shares were traded on the NYSE). And the breadth, while not the bullish 90% Upside Day we would like to have seen (90% of volume being prices ticking upward), was still very encouraging. One day does not a trend make, but the previous day, Tuesday, signaled the type of capitulation selling (big volume at 7.3 billion NYSE shares traded and virtually the inverse of Wednesday’s breadth) that just begs for the type of follow up we saw on Wednesday.
The Tuesday sell-off and the Wednesday buy-in signal a potential rally that could potentially last a few months and could potentially bring the S&P 500 up to about 1,325 points. We are willing to miss that rally as we assess the probabilities as to the sustainability of any renewed bull market.
Said another way, we are willing to give up a few percentage points on the upside when the risks so loudly echo those of 1969.