Never Again?

February 22, 2009

The losses keep mounting.  The week ended with a stinging 7% drop on the S&P, the worst weekly performance since early October 2008.  Year to date, the S&P is off almost 15%.

The catalyst?  Nothing in particular.  The data were weak–as usual–but perhaps investors are starting to realize (and price in) that a second half recovery in earnings may not happen.   Perhaps folks are fearing that this recession, as Paul Volcker suggested, is not your ordinary, run-of-the-mill recession.

The data (housing starts & permits, industrial production, and Philly Fed) continue to point to seriously weakening demand.  Inflation numbers jumped slightly–due mainly to gasoline price hikes–but nobody believes that this reflects the price increases normally associated with economic recoveries.

Corporate earnings and outlooks continued to disappoint, with HP, Deere, Comcast, XTO, Lowes, and many others reporting below expectations.

The Wall Street Journal this week made an interesting point about the mindset of long-term investors and their supposed hoards of cash, sitting on the sidelines just waiting to rush back into stocks when things get better.  If stock market losses continue to get worse, and if the losses don’t reverse themselves fairly quickly, then investors might not be willing to jump back in–for a long time.

In fact, the percentage of cash as a share of market value has jumped, but it’s jumped up to levels that are merely consistent with long term averages.  In other word, the growing piles of cash are reverting back to normal amounts, not relatively high amounts.

Today, with the S&P500 off almost 51% from peak, who can blame investors for losing faith in the markets?  Certainly, it’s becoming harder to swallow the argument (peddled primarily by the mutual fund industry) that stocks are always a must-have asset class, an asset class that should soak up a huge chunk of your capital.   Instead, investing in stocks may feel more like gambling–very much like people felt about stocks for decades after the Great Depression.

The good news?  Well if stocks did fall another 50%, to about 75% off peak (near to–but not quite–Great Depression levels), then investors could be offered the opportunity of a lifetime. 

The bad news?  Many investors will never dare to buy another stock again.


Japan’s Lost Decade….If We’re Lucky

February 15, 2009

Easy come, easy go.  This week, S&P gave back almost all of its gains from the prior week by dropping 4.8%.   The S&P has fallen in five of the first six weeks in 2009.  

The economic news was sparse but still gloomy: unemployment claims stayed well above 600 thousand, business inventories fell, and the Michigan sentiment index dropped much lower than expected. 

On the earnings front, most of the Q408 results are in, and this week’s actuals and outlooks were generally poor–again.  Interestingly, the as reported results for the S&P for Q408 will be negative for the first time in history; at the year end closing price of 903, the TTM P/E ratio is well over 30, implying that the market expects a massive rebound in earnings later this year.

How realistic is this?  Japan’s experience in the 1990’s suggests that it is not very likely.  At under 8,000 the Nikkei 225 is trading at approximately 80% below its peak of 39,000 attained in 1989–almost 20 years ago!

How comparable is Japan?  More than we realize. 

For starters, the nature of their crisis is very similar to ours:  the bursting of a real estate bubble and credit bubble. 

But in many ways, our problems and our proposed solutions are worse.  Our residential real estate prices doubled in the five years before peaking.  Japan’s real estate prices climbed only 50%.  Our credit bubble pushed total private (excluding government) debt to 300% of GDP; Japan’s peak level never soared so high.  Our net debtor status makes us dependent on the investment and savings of the rest of the world; Japan’s high domestic savings rate allowed it to borrow from it’s own people.  Also, most of the developed world is entering a severe recession today; Japan had the ability to export to stronger global markets to pull itself out of the abyss.  Finally, our credit bubble collapse is far more severe in the non-bank securitization markets, making it much harder to fix; Japan’s credit bubble collapse focused on the banking sector, a much more manageable problem than collapsed securitization.

 And our proposed solutions are no better than Japan’s.  In fact, we’re pursuing the same monetary and fiscal fixes that did not work in Japan.  The monetary stimulus is ineffectual (pushing on a string); the fiscal stimulus is both too small (liberal economists argue that we’re trying to fill a $3 trillion demand gap with $800 billion) and inappropriate (conservative economists argue that long-term spending projects won’t work as well as short-term tax incentives).  And most importantly, the credit fix matches almost exactly Japan’s initial failed efforts:  taxpayer capital injections into struggling banks (think Citi) holding worthless loans made to struggling households (think non-performing mortages ). 

Japan’s annual GDP growth averaged only 1% for all of the 1990’s.  Given our problems and solutions (so far), we would be lucky to average 1% for the next ten years.


The Market is Cheap…..Really?

February 8, 2009

Finally, the S&P rallied, rising 5.2% last week.  Although overdue for a bounce, the market climbed despite being hit with some of the worst economic and corporate news this year, so far.

Auto sales for the month of January were abysmal, with GM sales dropping a staggering 51% year over year.  Weekly claims surged to 626,000, the highest level since 1982.  Factory orders fell 3.9%, more than expected.  And the big number–payrolls for January–was disastrous: down 598,000 jobs, the worst job loss figure since 1974.  And finally, the unemployment rate jumped to 7.6%, also more than forecast.

Corporate earnings continued to disappoint:  Dow Chemical, Disney, Kraft, Cisco, Time Warner, News Corp., Biogen Idec, and many others reported fourth quarter 2008 results that were below consensus estimates.  To add insult to injury, many provided weak outlooks or withdrew guidance completely.

So the S&P closed the week at 869, about 45% below its peak in October 2007.  At a 45% discount, many market analysts are convinced that investors should “take advantage” of such depressed prices and buy. 

But let’s take a look at what constitutes depressed prices, using P/E ratios over the last 70 years, as provided by Standard and Poors.  Let’s also use trailing 12 month actual, not projected, earnings to remove the guesswork of estimating next year’s earnings.

What does history say?  Over the last 280 quarters (70 years), the percent of time the S&P500 was valued below a P/E ratio of 10 was 22%.  Even as recently as the 1970’s, the S&P500 was valued at a single digit P/E 40% of the time.

By comparison, where are we now?  As of last week, with about 65% of the Q408 reporting submitted, the P/E stood at a whopping 25. 

So it really doesn’t matter exactly how accurate your 2009 earnings estimate is–take $40, $50, or $60.  If our recession continues to deepen and lengthen, the current 25 multiple will come crashing down.  Let’s use the $50 estimate (which is much more optimistic than the current  top-down estimate–$42–published by Standard and Poors) and apply a multiple of 10 (possibly generous, given historical data) which gets us to an estimated S&P value of 500.

Now that would be cheap…..really!


Worst January Ever

February 1, 2009

The equity markets can’t catch a break.  After three straight weeks of decline, the fourth and final week seemed to be way overdue for a relief rally.  After starting the week on a solid three day upswing, the market crashed on Thursday and continued to skid on Friday.  The result?  Although the week’s decline was modest–only 0.7% on the S&P–the total drop for the month was historic:  8.6%, the worst in the history of the S&P 500. 

Why is this noteworthy?  Historically, the January performance has been correlated with the entire year’s outcome more than 70% of the time.   Knowing this predictive statistic, many traders and investors will be even less eager to jump in to put new money to work, increasing the likelihood of making the correlation a self-fulfilling prophesy in 2009.

What happened this week?  The economic data and corporate reports were especially dismal. 

On the economic front, Case-Shiller’s November 2008 data revealed that home prices fell at the fastest pace on record (since 1987).  Consumer confidence dropped to another record low.  Durable goods orders plunged, and continuous claims rose to 4.8 million, also a record.  New home sales fell off a cliff, and Q408 personal consumption expenditures fell by more than 3% (after falling by more than 3% in Q308, this back-to-back drop is the worst showing in decades).  Finally, the first estimate of Q408 GDP fell at a rate of -3.8%, the worst reading since 1982.  And it would have been worse, had it not been for the huge, and unwanted, build up in inventories.

On the corporate side, the news was bleak.  On Monday alone, almost 80,000 layoffs were announced, led by 20,000 from Caterpillar alone.  And there was a parade of firms that either disappointed with Q4 results or Q1 outlooks.  These included:  Texas Instruments, AT&T, Boeing, Wells Fargo, Ford, and even Procter & Gamble. 

Once again, the markets didn’t completely implode this week, in part because of the hope that the fiscal stimulus will stabilize the economy.  An initial bill was passed by the House and is now being amended by the Senate.  In one form or another, it Congress will pass this bill and Mr. Obama will sign it.  And nobody should be surprised if the equity markets rally, perhaps significantly in February, March or April, as they anticipate a postive economic reaction to the stimulus.   The question remains however:  in the long run, will the stimulus actually work? 

The smart money wouldn’t bet the house on it.