The house burns while many are still inside

Watching world markets implode this past year has been a strange experience. On the one hand it has been gratifying to finally see proof positive that we were founded in our concern and assessment that market risks were off the charts 2005 to 2007. Turns out, it wasn't just our imagination, things had gone crazy. After smouldering ominously for a couple of years, the structure finally did burst into flames last fall and has been burning up capital ever since. The hard part has been watching so many people stay inside while the fire envelops them.
With the incredible volatility and losses of the past few weeks, a period of at least an interim rally should be in the cards. Market indices have been so deeply pummelled that a rebound of up to 20% would not even reverse the down trend at this point. We recall the three separate 20% rallies during the bad bear of 2000-2002. For those that have remained improperly structured and over-exposed to equities throughout this bear market to date, strong clearing rallies would present another opportunity to downsize their risk.
Meanwhile we are watching carefully for a final bottom or at least a tradable bottom should markets rebound and rally for more than a few weeks. Belief and then panic have surged through the world the past several days. The pessimism has gone mainstream. Global fear is palpable.
A few things make me doubt though that we have yet found “the” final bottom this cycle. One reason is that despite losses of more than 30%, US markets we are still some 25% above the past cycle low in 2002. In Canada we are still some 38% above the ’02 low. We have always acknowledged that the horror of each cyclical bear within past secular bear markets was that at the end of each business cycle, the stock market came back to re-test its prior cycle low. We know that cyclical bears in secular bear markets tend to last longer and fall deeper than the average bear.
Another point of historic reference, is that total market losses during past recessions have been more of the -45% variety than the -25% to-30% variety we often see in less serious contractions. The tech wreck 2000-2002 triggered a very short recession and yet we still saw total losses of -45% on broad markets. We also have a much more vulnerable global economy now than in 2000, with multi-faceted problems of debt, low savings, imploding credit markets and almost unprecedented carnage in real estate. So it makes some sense to me that total market losses this time could be of the worst-historic-range variety.
Presently still elevated margin rates at brokerage firms are another harbinger of further selling to come. A report this morning confirmed that margin levels are still some 25% above where they are likely to bottom this cycle. The inevitable unravelling of this margin generally creates a self-fulfilling cycle of selling begetting lower prices and further selling. In past bear markets, margin levels have typically declined in lock-step with the stock market. So while margin levels have declined with the market some 25% from this cycle’s peak, a further decline of 25% in margin use, suggests a further potential decline of another 25% for the market from here.
These are all just some of the macro trends we are following to gage this decline.
For now we must wait, watch and measure some more. Our technical work still give us the best overall measure of where things are at.
We are glad to be out of the heat, but sad to see so many people still helplessly waiting inside.