Stocks Follow

(Photo: Toru Hanai/Reuters) The following is a condensation of an analysis issued earlier this week by McLean and Partners of Calgary. It doesn’t necessarily reflect my own view of where the market has going. Personally, I have no strong opinion on the probable short term move of stocks, or interest rates, or commodities or particular economic or geographical sectors. Certainly there are any number of gloomier prognostications floating around, from John Mauldin to Richard Russell to Peter Grandich. Depending who you read and believe, you could be completely in cash, completely in gold, completely short or some combination. So reader beware but those who are inclined to stick with the classic mix of 60% stocks to 40% bonds may find the McLean and Partners analysis worth considering. McLean and Partner’s Russ MacKay believes “the recent sell-off has many characteristics marking the probable culmination of the recent protracted bear market for global stock markets.” The firm has reviewed several indicators, which “lead us to believe that we are close to a market bottom.” 1. Time A typical bear market lasts 10 to 11 months with a range of 3 to 21 months, and a pullback of 21-24%. The U.S. bear market, which has led the world, has now lasted 10 months and the pullback to its low was just over 22%, in line with normal expectations. “A recession scenario could very well be built into the market already.” 2. Extreme Pessimism The current bear market was precipitated by the collapse of the U.S. housing market (the worst since the Great Depression) and has now reached an extreme as the “bubble” that was burst. It is at such levels of extreme pessimism that we can often expect stabilization and a possible recovery. MacKay doesn’t expect to see normal housing markets until early 2009. 3. Commodity Sell-off Because oil has been a major headwind to world economic growth, we needed to experience the recent sell-off in oil, energy and metal stocks. However, the significant sell-off in oil prices over the past week is important because it means we may have seen a near term peak in oil prices induced in large part by OECD demand destruction. Although the world is still facing tight oil supplies over the longer term, a sell-off in oil, as painful as it is to an energy investor, is also bullish for the overall stock market 4. Improved Earnings We have seen several significant U.S. rescue packages showing regulators will not allow the financial system to fail. This occurred with the Fannie Mae and Freddie Mac bailouts and followed the bailout of Bear Stearns and the creation of the Term Auction Facility. Just as important are the 2nd quarter Earnings per Share reports of key financial stocks such as State Street, Wells Fargo, JP Morgan and Bank of America that clearly indicate that analyst expectations for EPS are likely too negative. With EPS deterioration coming to an end, the financials may have stopped being the market loss leaders. 5. Interest Rates Real interest rates are negative and borrowing spreads are far above normal. This suggests that reversion to more normal levels is more likely than further significant upward expansions 6. U.S. Employment While U.S. employment has weakened, it has not reached the poor levels normally associated with serious U.S. recessions. Initial claims have leveled off, portraying an employment cycle that has stabilized at higher levels than would normally be expected in a more serious recession. This suggests that even though the consumer is poorer because of housing, they have not lost jobs to the same degree as in prior recessions. 7. Capitulation of the Market Bottoms are typically reached when investors “throw in the towel” and indiscriminately sell everything with little regard for value. When the Capitulation Index is below -1.5 as it is today, the stock market is typically positioned for a recovery. 8. Extreme Volatility Market bottoms are characterized by extreme levels of market volatility, measured by the VIX Index. When this index reaches very high readings of 30 and above, as it did this past Tuesday, the market is typically well positioned for a recovery. 9. Advisor Sentiment Low U.S. advisory sentiment reached extremely low levels in March 2008, October 2002, October 2001 and October 1998. This measure of market sentiment is a contrarian indicator. Levels as low as these illustrate when the markets are typically oversold conditions and typically precede a market recovery. 10. Presidential Election Markets tend to perform well in U.S. presidential election years. The US markets have increased a little over 6% on average over the past 104 years of US presidential elections. MacKay closes by saying that recent events are "likely to mark the early stages of a market recovery, but it is likely to be quite volatile and try investors’ patience.” --60--