The late date rally on Friday was long, long, overdue. Sadly even with 5%+ gains, the markets still finished steeply lower on the week. The carnage of 2008 while not unprecedented will be legendary on all metrics. When markets become so relentlessly oversold, it is usual to expect at least interim days and weeks of a counter-trend rally. Maybe we are seeing some follow-through on that hope today. Europe rallied strongly today as news of the Citi bail-out part 2 spurred fresh hope.
The question is will this rally have some staying power over the next few months? Will it be the start of a cyclical shift back to the next bull? I would be content if it were. I doubt that it is. Yet. But we will watch the technicals carefully as always.
Despite the 494 point rise on the Dow late Friday, we see that in the broader market, there were 1245 new lows and only 2 new highs–poor breadth. We also know that the Lowry’s buying pressure broke to yet another new low, while selling pressure broke to a fresh high. This is a menacing combination.
Meanwhile there is no question that fundamental valuations appear much more favourable today than they have for the past several years. One can't help but notice for example that dividend yields on REIT ETFs that were less than 4% in 2006 are now about 12%. Financial shares are yielding more than high quality bonds and this is as it should be. As we have seen vividly over the past 13 months, financial shares can carry a lot of financial risk. A few years ago people were blindly holding risk assets without any likelihood of adequate reward. Investors have now learned the hard way that they need to be adequately compensated for the risk of holding equities. This is a good lesson to learn.
Reading the Citi group headlines this weekend invoked a spate of déjà vu. Weren’t “SIV’s in the Citi” and Bear Stearns how the credit crunch first hit front page news many months ago? I hate to be a party pooper, but bailing out Citi group-encore -won't be the systemic change we need to re-launch our next economic expansion.
The stats on the bail-out efforts to date are incredible:
“The U.S. government is prepared to lend more than $7.4 trillion on behalf of American taxpayers, or half the value of everything produced in the nation last year, to rescue the financial system since the credit markets seized up 15 months ago.
The unprecedented pledge of funds includes $2.8 trillion already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, according to data compiled by Bloomberg. The commitment dwarfs the only plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program. Federal Reserve lending last week was 1,900 times the weekly average for the three years before the crisis.”
See Fed pledges top 7.4 trillion to ease frozen credit
To put this in modern historical perspective, the savings and loan bailout of the 1990s cost $209.5 billion adjusted for inflation, of which $173 billion came from taxpayers, according to a July 1996 report by the U.S. General Accounting Office, since renamed the Government Accountability Office.
The 1979 U.S. government bailout of Chrysler consisted of bond guarantees, adjusted for inflation, of $4.2 billion, according to a Heritage Foundation report.
U.S. financial firms have taken write downs and losses of $666.1 billion since the beginning of 2007, according to Bloomberg data.
I remember last winter when the US financial firm write down estimates were at 200 billion and many were calling that an ultra-bearish estimate. 200 billion is truly chump change nowadays.
It seems clear that this is already the worst capital markets crisis in modern history. But despite market losses of 45% on most stock indices around the world, this bear market is definitely not “unprecedented” or the worst ever in modern history. In risk premium spread and volatility 2008 already matches other bad bears like 1932, 1974, 1982 and 2002. With the clarity of hindsight all of these years turned out to be end of cyclical bears. In each case the markets rallied for months and years off these market bottoms.
What troubles this conclusion though is that in each of these cases the market had experienced at least a 2 year bear market before hitting bottom. The market crashed from 1929 to 1932, 1973 through 1974, 1981 and 1982, 2001 and 2002. Could it be that these extended decline periods were needed to clear out the over-levered participants from the prior reckless period?
The length of the 2008 bear has so far been just one year. Could it be that we have corrected for all the over-exuberance this time in just one year? If this is the worst capital market crisis in modern times, is it reasonable to expect that we have seen the worst of the stock market declines? Possibly. Only time will tell us for sure. But we need to have an investment plan that is prepared for either outcome.
Cory’s Chart Corner
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