Tuesday, December 9, 2008
- In our November 30, 2008 article “The Mother of All Bear Market Rallies,” we admitted that while we remain cautious that we are “keeping an open mind” as to whether or not this current rally may, indeed, prove to be the beginning phase of a new, multi-year bull market.
- Dow 10,000 could very well be in the works for this rally. And while we maintain that aforementioned open-mind, simple price movement alone will not compel us to become more bullish. Within the rally we need to see the improving technicals we have been looking for all year (most notably improvement in volume, breadth, buying pressure, and selling pressure).
- The current rally has been impressive enough for us to finally start thinking and talking bullish again. However, we maintain that discretion remains the better part of valor as the current rally appears to be more similar to the largest of the past bear market rallies rather than the beginning phase of a new, multi-year bull market.
- Despite our continued cautious tone, we continue to add to our list of bullish evidence. It is becoming more and more likely that we could begin adding to risk (i.e. using cash to move back into the debt and equity markets) as early as January-March 2009.
What is the significance of the huge percentage losses suffered by the 2008 bear market? Following is a list of the largest bear markets of the last century in terms of percentage losses for the Dow Jones Industrial Average (DJIA):
- 1929-1932, DJIA down 89.2%
- 1937-1938, DJIA down 49.2%
- 1906-1907, DJIA down 48.6%
- 2007-2008, DJIA down 46.4%
- 1973-1974, DJIA down 46.1%
So we are pretty much there in terms of matching other major bear markets of the past, except for the 1929-1932 Great Depression era. The question then becomes, are we entering a depression in terms of this market going any lower. We already discounted basically the worst anybody has seen since 1937-1938. So what more could go wrong? Are there more shoes to drop?
Berkshire Money Management is concerned that there are more shoes to drop – even if they are much smaller shoes than those of months prior. As a result, although the lows for this market may actually have been realized for this bear market, we prefer to see more evidence before we act more courageously (i.e. risk your capital). Instead of expecting a V-shaped bottom where the DJIA reaches 15,000 in a year, we expect the more optimistic scenario is for the DJIA to reach 10,000 in weeks but to ultimately behave more like 2002-2003. In 2002 we saw, essentially, a dual-bottom in July and October of 2002, but the new, multi-year bull market did not really start until March 12, 2003.
In the recent past we have written a lot about what we need to see to become more optimistic about the sustainability of any rally. And we are certainly seeing bullish signs: slightly improving volume and breadth compared to previous rallies during this bear market; declining supply (selling interest); improving demand (buying interest). But we are not just watching the rallies we are also watching the quality of the pullbacks. And there will be pullbacks – there always are.
Will the quality of the pullbacks be of the nature that selling pressure is starting to dry up? If that is the case, then we are probably looking at a 2002-2003-like sideways process.
But if the quality of the pullbacks witness selling pressure expand and accelerate then the chances would greatly improve that we will see new lows.
Back to the subject of rallies, how significant has the rally off of the November 20th low been? To answer that question, we have to examine what has happened in the early phases of new, multi-year bull markets since 1932 and compare it to this rally. From the closing low of November 20, the DJIA advanced 16.9% in its first five days.
We looked at all of the new, multi-year bull markets and in the first five days the average gain for the DJIA was 7.6%.
- The largest such five-day rally was 16.6% off the October 19, 1987 low (following the crash).
- The next largest such five-day rally was 13.1% off the 1970 low.
- The third largest such five-day rally was 9.4% off the March 12, 2003 low (the advance was 12.8% in eight trading days).
- Again, to reiterate, the average five-day rally has been 7.6%.
Obviously, 1987 was a bit of an exception as it followed a massive one-day crash. 1970 was the most interesting example, by comparison, but the difference was that the market took off on decent volume back then (this time volume has been decreasing). So this large and more current move of 16.9% over five days has not been typical of the beginning of past new, multi-year bull markets.
But now let us look at not the average rallies at the beginning of new, multi-year bull markets, but rather at the largest of the bear market rallies. The current rally is more similar in nature to those.
- From the July 2002 lows, the DJIA rallied 13.1% in four days.
- From the October 2002 lows, the DJIA rallied 13.3% in four days (it rallied 17.0% in eight days).
- In 1929-1932 there were nine rallies of ten percent or more with an average length of eleven days.
- In 1937-1938, there were four rallies of ten percent or more with an average length of sixteen days.
- In 1973-1974 there were three rallies of ten percent or more with an average length of sixteen days.
A direct comparison cannot be made here, but certainly the current rally has so far been more typical of the largest of the bear market rallies and has been atypical of the early phase of new, multi-year bull markets.
To answer that same question (How significant has the rally off of the November 20th low been?) with different data, let us add to the question the painful premise that we have recently experienced a rare event as the DJIA plunged greater than 23.5% in three straight down months. Since 1900 there have been ten prior cases of this occurring. As noted in the table below, the forward results were very good, but not spectacular. However, the DJIA was higher 80% of the time three and nine months later.
While there is evidence that the market may continue to go up from these levels, economic conditions combined with history suggest to us that for clients with large amounts of cash we still have time to dollar-cost-average into the stock market through 2009..
DJIA Loss of Greater Than 23.5% in a 3-Month Period
With All Months Down
If we are, indeed, going through what is likely to be a bottoming process for the stock market, why don’t we start buying equities now? As has nearly become a mantra this year for Berkshire Money Management, discretion remains the better part of valor.
In this economy, even though the bulk of the duration and the magnitude of the recession may be behind us, that does not rule out the potential for further dropping shoes. Six years ago, in October 2002, we had the luxury of being heroes and jumping from almost all cash to almost all equities because after a precipitous drop for the market we were able to correctly forecast an economic backdrop of global prosperity.
Six years later, to repeat ourselves ad nauseum, discretion remains the better part of valor. We want to buy the rally. We do not want to be buying aggressively as we are just bouncing around the bottom (or in a range) because that is basically dead money with the potential to become lost money. It is our opinion that this bear market is extremely oversold and is “due” the Mother of All Bear Market Rallies. But that certainly does not rule out that there could be further problems down the road.
We are better off to skip the exercise of trying to identify the bottom of the stock market as it occurs and instead try to position ourselves to move into the market in the early phases (first five or six months) of any new, multi-year bull market (not the first five or six days, or even the first five or six weeks).
Closing Bullish Comments (with a caveat or two)
The S&P 500 dividend yield is 3.2%, a 17-year high. As impressive as this is, especially relative to historically low interest rate yields, this is still below its long-term average of 3.7%. This is consistent with price-to-earnings metrics, suggesting that dividend yields are high enough to support the case for further gains in the current rally. The caveat is, however, that they are not yet high enough to support the case for the type of long-term secular low realized in 1982. Still though, this is very bullish for the short-term.
Also bullish for the stock market is that over the weekend, President-elect Barack Obama said he will put forth the largest spending package on infrastructure since the 1950s. Also, legislators are said to have reached an agreement with the Bush administration to bailout the auto companies. The caveat here is that the only good news seems to be bailout-news.
By reviewing economic and stock market trends during and after bear markets, regardless of how stocks perform during a recession, the market is nearly always advancing strongly by the time the recession is three months from its “official” end. Assuming stocks do not begin a strong advance until the last three months of the current recession, we may see an “official” bottom in stocks as early as the first quarter of 2009. The caveat here is that this could be a 24-month recession instead of an 18-monther.
Further bullish contrarian comments:
- In October, the total money market assets are 78.8% of domestic and global stock mutual funds, higher than at the 2002 lows.
- Another way to look at potential cash is that the value of money market mutual funds relative to the total market value of all U.S. stocks was at a record high at the end of October.
- After a year-and-a-half of plunging stock prices and earnings, for the very first time in this cycle, Wall Street earnings estimates have turned negative for the next twelve months. (Ironically, this has historically been bullish for stock prices).
To sum the bullish comments, the public investor is selling stocks and bonds at record extremes and now hold record cash on the sidelines (relative to stock funds). Combine these with reasonable valuations and (finally) more sober earnings forecasts on Wall Street, many pieces are in place for a bottoming process in the stock market.
Bottom Line: The market is oversold and seasonals are bullish. We expected a large and impressive rally in the stock market, and on a historical basis this has been huge and may yet continue. But Berkshire Money Management’s primary goal at this time is simple – we do not want to make a disastrous mistake. The economy continues to make investing a very high-risk endeavor. We are growing more bullish, but we remain more cautious than bullish.
It remains to be seen if this rally can be sustained, but given the growing bullish factors we will keep an open mind as to whether or not this is the beginning phase of a new, multi-year bull market.