Today markets are bouncing with another surge of hope. As I have noted before, bear markets are typically populated with many days and even weeks of strong up rallies. But here is the thing. If world stock markets have put in their bottom already this cycle, then it will be a very resilient, shallow, even miraculous bottom. It will be one of the shallowest declines, stopping at the richest valuation levels ever in history. And it will achieve this remarkable feat amidst the on-going terrors of the worst credit and housing recession since the great depression. I would like to believe in this miraculous outcome, but I confess that I have a difficult time accepting that we have seen this bottom yet.
Here are a few relevant articles that I think we should consider before jumping blindly on to the bull bandwagon:
Did the US Economy really finish Q4 2007 in the black and Escape a fourth quarter drop?
Real GDP (after inflation) is obtained by dividing nominal GDP by the GDP deflator (x 100). The smaller the deflator is, the less of GDP gains can be attributed to inflation. Had recent changes to the GDP deflator not happened, Real GDP would very likely have been 0.0% — or worse.
Last year, Fed economist Jeremy Nalewaik suggested that a better measure is GDI, or Gross Domestic Income. Nalewaik argued in a 2007 paper that GDI “has done a substantially better job recognizing the start of the last several recessions than has real-time GDP.”
According to Nalewaik, GDP-based models did much worse at forecasting recessions than did GDI: The past four recession odds at their actual starting points were only of 52%, 40%, and 45% and, for the 2001 recession, just 23% according to GDP data. The alternative measure of GDI did must better, signalling odds of a recession of 78%, 44%, 72% and, for 2001, 70%.
And what of recent data? It shows an annualized GDI decline of 1% — its largest drop since the 2001 recession. The present GDI data suggests that we have already been in this recession for several months.
In addition Lowry's the oldest technical analysis service in the US, put out a long note yesterday which concluded that “our analysis of the forces of supply and demand suggests that calls to buy may be premature.” As Lowry's points out the average bear market since 1949 has been -29% on the S&P 500, a lot worse than the -18.6% decline since its peak this time in October 2007. Several bear markets have been much more severe:
Ned Davis Research points out that since 1900, cyclical bear markets in stocks that have taken place during secular bear markets (like the one we entered in 2000) have lasted about 17 months or twice as long as cyclical bear markets that have occurred during secular bull markets. This bear market started in October 2007, so bottoming now within 5 months would be historically truncated by about a year.
Lastly, as we wait for the next knives to fall on unsuspecting investors, it is useful to note that analyst earnings expectations are still incredibly high looking out over the next 3 quarters of 2008 and into 2009. Watch this video podcast as to why. My question then is how can the market discount accurately an earnings contraction that it thus far refuses to see?
Cory’s Chart Corner
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