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A tale of two worlds - some perspective on the markets today

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June 05, 2009 – Comments (8)

Imagine two worlds.  Both worlds had the S&P at 1500 in late 2007, both worlds have the S&P at 940 today.

In one world, this one, the S&P started sliding down in late 2007, crashing into the 800's after the credit markets siezed following the fall of lehman.  A hedge fund liquidation panic caused a very sharp, brief pointed drop to 740 on the S&P on November 20th before the markets settled into a 900ish trading range.  Then in mid February a huge prolonged selloff began that drove the markets to 670, a bounce followed, returning them to a 900ish trading range.  We'll call this WORLD A

In one world the S&P started sliding down in late 2007, crashing to the 800s after Lehman Brothers went under and having an epic downturn bottoming November 20th.  Eventually the volatility waned a bit, but the market just kept sputtering between 850 and 950, fluttering around the 900 mark.  Months go by and the markets never really move, fluttering around the 900 mark into their 7th month now in June 2009.  We'll call this WORLD B

In WORLD A the headlines scream of a rally, people warn that everybody is too bullish, people holler about there being a new bull market, others are frustrated that the market is up so far, can't believe how high stocks have gotten, people fear an imminent crash because the market is so vastly overextended (I have personally posted my fear of such a thing repeatedly here on the CAPs game, only to have it never materialize as I feared).  Its a wild, manic world with wildly varied opinions and heated debates.  But a positive feeling definitely exists. 

In WOLRD B, if you can use your imagination for a moment, I think we'd have a very different mood.  The headlines would read "bear market enters 18th month, S&P stuck well below 1000".  Talk would be gloomy, nobody would feel too bullish, we'd all be sitting around wondering if things would ever get better.  Negativity would probably be even higher than it still is in WORLD A.

So we'd have two very different outlooks and attitudes.  In one world things are at least spottedly optimistic and happy, in the other things would probably be pure gloom and doom still. 

But the net result in each case is exactly the same.  Save for people who got out below S&P 850 or so, and people who got in an the severely depressed levels of feb/march.  The former lost, the latter gained, but the overall position that society is in is exactly the same in either case.

My blog from earlier in the evening started out intending to suggest that the markets have been consolidating gains and retracing even if the broad indexes haven't necessarily reflected this.  It ended with an alternate view of this bear market being offered - the WORLD B view, if you will.

I think that the variant view that we aren't really in a market rally, but rather a bounce back to a trading range around 900 or 920ish on the S&P until more details about how the recession and fiscal policy and all of that will play out become clear may well offer a better perspective on where things sit than viewing the market as being in a big rally. 

This train of thought - that viewing the market as being in a now 7 month state of being about 40% depressed from its previous highs makes more sense than viewing it as in the beginning stages of any big rally - may offer a better perspective on where things stand.  Its tempered my fear that another enormous crash is imminent, but its also tempered my hope that my exit point of S&P 1000-1100 draws nigh.  We may have a stock pickers or a traders market for a while, tied up in a trading range centered somewhere around where we are today. 

A good stock picker may fare well if these ponderings prove accurate.

And, as always, I should note that I do not have a stellar track record for predicting short term market moves, or market moves at all and nobody should amke decisions with their hard earned money based on my thoughts or assumptions about market movement. 

8 Comments – Post Your Own

#1) On June 05, 2009 at 9:14 AM, carcassgrinder (35.58) wrote:

http://www.baltimorechronicle.com/2009/052909Lendman.shtml

 

...This article will explain why both of those worlds are fictitous and contrived.

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#2) On June 05, 2009 at 11:12 AM, 4everlost (29.37) wrote:

carcassgrinder - wow, what a wild article that is...

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#3) On June 05, 2009 at 9:12 PM, Donnernv (< 20) wrote:

Nice observations about World A and World B.  But I think there is a useful longer term view, in which your worlds are but a small time segment.

The economy and the way people lived in the 1950-1960 era represents normalcy.  I lived through it.  If you bought a house, you put 20% down (or 10% FHA) and had to meet strict lending standards imposed by your local banker, who knew he'd have to carry that loan himself.

There were no credit cards (well, Diners Club, but no one I ever met had one).  Basically, if you couldn't pay for it, you couldn't buy it.  No one expected home prices to rise much, so that wasn't a consideration in your financial management.

The stock market didn't do much, so dividends were a big consideration.  Long term investments were just that, long term.  If you bought IBM or GE and stuck with it, you made out well.

Everyone saved, because no one thought SSI would support them when they retired.  No one expected it to.  Colleges had meaningful entry requirements and those who couldn't pass muster didn't go.  Many went to technical or trade schools to learn a useful trade, and prospered.

That economy was sustainable and happy for most.  Since 1983, the nation has gone on a bender.  We've all seen the results.  It's not sustainable.  What we need, and will occur whether or not we choose it, is a reset.  A reboot.

The nation will never again be as it was in the 50s and 60s.  But after the reboot, it'll be a lot closer.  And the pain will be tremendous on the way down.

It took 25 years to get to the full extent of this mess.  It'll take at least ten years to get back to a sustainable economy.  And it's tougher now.  Our manufacturing base has been badly hurt.  Or international competitors have developed enormously.

We must depend upon our technological prowess to rebuild.  It will take time.  Years?  Sure.  Decades?  Maybe.  But that's the reboot we must have.

Now, our education is inferior.  If tats, piercings and raves counted, we'd be tops.  But they don't.

During the reboot, I think the markets will waffle along between 750 and 950 for years.  John Mauldin's "muddle through economy" is here.

Me?  I'm investing for solid dividends.  The S&P from 750 to 950 is a gain of 27%.  Everyone gets all excited by the new bull.  The S&P from 950 to 750 is a decline of 21%.  The world is ending.  I think a longer term view is warranted.  Looking at the market every hour of every day leads to a lot of short term over-reaction.

Just my 2 cents.

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#4) On June 05, 2009 at 9:25 PM, dividendhound (< 20) wrote:

Nice discussion man, I think you add a lot on this site that is helpful to a lot of us.  My own two cents is that some foreign markets might fair better than ours, and that finding gems in those markets will help in the long run.  Plus, then you get some currency diversification.

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#5) On June 05, 2009 at 9:41 PM, portefeuille (99.61) wrote:

In one world the S&P started sliding down in late 2007, crashing to the 800s after Lehman Brothers went under and having an epic downturn bottoming November 20th.  Eventually the volatility waned a bit, but the market just kept sputtering between 850 and 950, fluttering around the 900 mark.

As I said here. It is boring. I also added the chart: 1.

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#6) On June 05, 2009 at 11:03 PM, Donnernv (< 20) wrote:

Port:

It's just as I posited.  If you look at one week or one month market behavior, you get wound up in this week, this month, this quarter.  This is going to play out over a much longer term.

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#7) On June 06, 2009 at 12:59 PM, checklist34 (99.69) wrote:

Donnernv,  this is my first bear market / market crash in which I've been an active participant or an active onlooker.  I was an onlooker (but had no money) during the big nasdaq bubble in the late 20th century.

I remember the talking heads on CNBC during the nasdaq bubble, I remember the headlines.  I remember the mania, I remember how everybody KNEW it was justified.  One headline read "congratulations, if you're reading this you're going to be a millionaire" talking about an article mentioning investing in tech stocks. 

I remember an article, from early 2000, listing MSFT, CSCO, DELL, QCOM, INTC and the other mega cap high flying tech names from the period as the best investments for the next 20 years.  These were, of course, very bad calls. 

I remember people saying that valuations like p/e made no difference anymore because this was a new economy, and old economy cmpanies were done, this is new, different, THIS TIME IS DIFFERENT. 

And a few months ago all the talking heads had the exact opposite opinion, ...  except this time things were going down forever, not up forever. 

S&P 800 was predicted when we were at 1000, and that was shocking.  At S&P 800 someone predicted 600, at 600 many predicted 500, 400 and lower.  It became a game not of endless pumping but of upping the shock-factor ante to try to get on TV or get clients or get speaking engagements or whatever.

Stocks were going down forever, we were all going to die.  And soon, and badly. 

As an onlooker in 99 i was wrong for a year and a half about the tech bubble, but right in the end.  As a participant in this bear market I just got in slowly figuring no matter how long I was wrong and things kept going down, eventually going long would be very, very right and i'd make a pile.  The pile came quicker than I thoguht, happy days.

So my point is that I've only participated in 2 big events in economics and the stock market.  And i've only seen how 1 of those events ended (the nas bubble). 

But i'd guess that in 2002/2003 people KNEW the US was done, they KNEW things were different, they KNEW it was all over and we were done, down forever, never coming back.

And I'd guess that in 1974 they KNEW this was the end too.

and in 1983, and on black monday.  And I'd guess that, just like the nasdaq bubble, in 2006 people KNEW houses were going up forever and in 1967 they KNEW something too.

 

My investment philosophy this time around has been based on a stock picking strategy revolving around David Dremmans book on contrarian investing combined with some things Dremman didn't discuss, like looking at how far stocks had fallen from their highs, and more importantly, how historic their lows were.  ASH is my largest holding, i bought it at all time, historic lows (actually about 50% below its previous all time low).  I bought AA at 20 yeaer lows, same for DOW, etc. 

The economic or macro component of my philosophy was just to assume that what is today will not always be, and like every time before neither mania nor panic are ever right, even if they are partially right. 

In the NASDAQ bubble I lent a level of objectivity to my belief that these stocks couldn't go up any more by comparing their market caps, if they continued to give good returns, to the GDP.  CSCO at its peak was 600B market cap.  For routers and stuff.  if it grew 15%/year for 10 or 15 more years it'd have been multi-trillions of market cap.  Not happening, no way the market cap for a company that makes routers will ever justify a market cap thats a significant fraction of the GDP, like a REALLY significant fraction.  The p/e's were triple digits, the p/b's must have been far into double digits. 

It really was that simple, there was no way for these stocks to keep going up, it was inevitable that they crash. 

I think a similar analysis, similarly simple, and similarly potent, could be done today to assess the potential scope of the credit and real estate bubble. 

What % of the GDP, of overall spending, is beyond the means of the people spending it?  100% of the money i spend is on credit cards, for example, but I pay the bills every month.  Its alot easier than carrying cash or a checkbook. 

Is it 5%?  So that would mean that the GDP would have to reset 5% lower and begin growing again?  Is it 2%?  10%?  0.35%?

This bubble, it seems to me, began with welfare.  And now the government is trying to welfare us out of it.  Began with welfare because 2 presidents before Obama touted the need to get every american into home ownership.  Bush called homw ownership an ultimate freedom.  Those who can own homes and wanted to already did, nobody stopped to think that some people can't or shouldn't.  So they basically encouraged banks (now derided by the same politicians for their evil greed) to lend to everybody, which created a demand bubble for homes, which send prices up, bubble popped, here we are...  with a government now trying to welfare us out of it. 

But, ultimately, where should the GDP fall to from its bubble levels?  What is fair value for the S&P?  Were the levels in 2007 radically too high from a historical perspective?  I believe they were in 1999/2000, and I think they were in 2007...

But i've never sat down to calculate what effect on GDP growth various credit excesses have had.  But historically when things are bad the badness gets blown wildly out of proportion, when things are good the goodness gets blown wildly out of proportion.

So, betting with history, I'd guess that its not good but not quite as bad as everybody makes it out to be.

The dot coms did every bit as well as people predicted, i think online commerce actually got BIGGER than some bold predictions from 1999.  CSCO is a DJIA component!  Tech truly did live up to its billing.  But the stocks went way, way, way down anyway, and probably won't ever be back up.

Is anybody willing to bet that even if this recession lives up to some of the wild billings in the long run that stocks still won't go back to 670 on the S&P?

See what I mean?  Its never about business conditions or future prospects or trends, its always, in the long run, about fair value.

The question is just whats fair value.  My overall estimate for fair value on the S&P these days has been 1000-1050, a number I came up with via various means and which nobody else should take overly seriously.  My plan has always been to exit at about that point, or start exiting at about that point anyway. 

 

This has been an incredibly long and rambling commentary, I hope it was at least somewhat interesting.  I do understand your concern, Donnerv, but I think perhaps we should sit down and quantify it.  Maybe we should start a fair value thread where everybody offers their thoughts for fair value on the S&P, but ban trolls and people who won't "show their math" on how they came up with it. 

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#8) On June 06, 2009 at 1:03 PM, checklist34 (99.69) wrote:

all: i had no idea that post had gotten that long, and i will sign the "excessive rambling" form if somebody faxes it over to me.

Raging:  thats for the kind words if you meant them for me, I do appreciate it. 

You are SO VERY VERY RIGHT that its a good idea to have currency diversification in ones stock holdings.  I regret selling my shares of FEED to take a tax loss and then forgetting to buy them back 30 days later.

TCK is one of my very biggest holdings, its in Ca $$$, ... 

And overall I should sit down and try to estimate what % of the business done by my portfolio is in what currency.  Thats a genuinely good slice of advice. 

 

Porte:  your style always makes me grin, even if at times I miss the point of the subtlety

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