Still Bearish: FA and TA on S&P 500, Observations on the Economy
Okay, I know this is probably old coming from me, and with the number of Caps Bears talking about an imminent turnaround, why read one more? Why? Because this post has: Fencing, fighting, torture, revenge, giants, monsters, chases, escapes, true love, miracles... …. Okay, so maybe it doesn’t. But it does have some moderately intelligent observations, and the acerbic wit that you have come to love from binv :)
The current fundamentals, how shall I put this, … stink. Not just “excuse me I just ate a salad” stink, but “watch out I just ate a pot of chili that has been sitting out of the fridge for a day” stink. So why did we rally to begin with? Because we were at historically oversold conditions and pessimism was at an all time high. That’s it. Conditions were ripe for a very good bear market rally. Extreme fear cannot exist forever and nothing goes up or down in a straight line. It is just that simple. There are several factors to the economy that stink and make me deeply suspicious of anybody saying that the worst is over. Earnings, Unemployment, Upcoming Alt-A and Option ARM resets, Home Prices, and worst of all: Financials.
What a complete and utter joke. Earnings estimates for the S&P 500 for 2009 right now are somewhere between $35 and $45 (discounting the Pollyanna’s and the uber-bearish). There is obviously no consensus here, because estimates are estimates. But lets take an “average” value of $40. Based on the current price of the S&P at ~$925, this gives a P/E of …. 23 …. !!!!!! ARE YOU KIDDING ME!!!! When the S&P got down to 666 and still using earnings of 40, the P/E was 16.7. That is still absolutely nowhere near any real bear market bottoms (which are typically between 6 and 10). We are still even above the average earnings of the S&P which is historically 12-14.
So let me get this straight: P/E goes from about 45 at the peak (complete insanity) down to 17 (still way above average) on some of the worst economic news EVER, and we have a bottom? Seriously?
Go away and come back when we have a P/E of 10, then I will start listening to you.
So many of us have ranted on the BLS unemployment numbers, the games that are played, the revisions, the bogus “birth-death” adjustments, jobless vs. unemployed, etc. etc. However, there is one thing that the BLS can’t hide: trends. Take a look at the unemployment trends from the BLS website (16 and older, seasonally adjusted):
Now I believe the actual unemployment rate is a lot higher, but the BLS reports or “adjusts” them artificially downward. But they always have. The TREND is what is important here. And if you looks at the unemployment rate it is not leveling off, in fact it is just the opposite. The trend is accelerating (i.e. the change in the slope of the curve is a positive number and increasing).
Upcoming Alt-A and Option ARM resets
This video was passed around in Caps back in December when it originally aired. It is a 60-minutes piece (exceptionally informational and well done) on the upcoming Alt-A and Option ARM wave. If you have not watched this, please do so here . Actually, even if you have watched it, watch it again. This is a BIG DEAL.
The jist is, that the second wave of the mortgage meltdown has not yet hit, and we are just at the very beginning of the second wave. Check out the chart at 3:48 of the video above. Now couple this with the unemployment observations I have made above. When these mortgages all reset to higher rates, do you think that the economy will escape from the huge number of default rates, especially from the newly unemployed? Do you have any clue what this will do to consumer spending for people that can now just barely afford their mortgage? Do you honestly believe that we can refinance our way out of this mess (which would just further push the problem out instead of fixing it, despite that fact that this won’t work to begin with).
With rising unemployment, second wave of mortgage defaults coming, and continued back economic data pouring in, does anybody believe the NRA that we have seen the bottom in housing? Not me at least. And if home prices continue to decline (which on average they will) what do you think this will do to consumer spending? That’s right, it is going down. And if consumer spending accounts for the biggest portion of GDP (currently about ~70%), what does that do to GDP? Again you are right, it is going down. The structure of the economy needs to transition from consumer spending to production. That is the only way the economy will truly start growing again. Any attempt to re-inflate home prices / housing bubble will be a huge catastrophe (throwing money down a black hole) at worst and simply push the problem to the right at best.
In an effort to keep my blood pressure down, I will refrain from going on a tirade about financials. But let me make several observations. Consider the Unemployment, Alt-A and Option ARM resets, and home price issues I outline above. This will hit the economy hard in general, but it will hit the financial sector the hardest. Like I have said on many occasions, the financial sector is the cancer of this economy. Do you think the financial institutions have seen the worst when it comes to write-downs from the mortgage crisis? Not a chance. The recent mark-to-“imagination” rules are 1) a joke but 2) address only the first wave of the subprime meltdown. Wave 2 is coming and is potentially much larger than wave 1. But lets look at a few more reasons why financials are bad investments right now.
1. Financials have no real earnings right now. That’s right. I will invite you to read this article by Thomas Tan: How Much of the Banks’ Earnings are Real? . This is an excellent summary of the falsity of financials purported earnings. This article discusses: current mortgage refinancing, loss write-down postponement, accounting loopholes, etc.
2. Stress Tests were NOT good news. No matter how it was spun, read past the subterfuge. The banks are not adequately capitalized. And the problem is even more dire than test would suggest (as the tests were designed by the same financial institutions and economists that failed to see the current financial / mortgage meltdown). There is so much money tied into these long term CDS that have no (absolutely zero) possibility of ever being worth what was paid, even after the current round of write downs. When the next panic occurs, and it will, we will see a huge round of financial institution bankruptcies. The problem, of course, is maturity transformation.
3. Most of the banks are making huge share offerings at significantly lower prices than current market prices. Whaaaaaa…. ????. Why would that be? (Other than the fact that they are not worth current prices) GMX and outoffocus have a great discussion here about this: The Market Is About To Plunge (Day 9, Vol.8)
This last one (financials) more than anything causes me to call BS on this rally. This is because financials have been leading the whole charge. Financials stink, they are the cancer of the entire economy. And the “fixes” to financials discussed above are a joke. So when I see XLF or the Philly Banking Index up OVER 100% off the bottom in less than 2 months, I laugh. It is too ridiculous.
Real bottoming will be lead by new industry and manufacturing. We will see lowering unemployment. We will need to see a cleaning out of financials (many bankrupt from accepting the true consequences of bad derivatives / mortgage bets). And what are the chances of this happening in the next year? Almost zero.
This rally is literally just a technical correction. The market on weekly and monthly terms (see below) were so extremely oversold. But this rally is not based on fundamentals. And the move the last 3 weeks looks like gambling euphoria: Worst is over! Bottom is in! Buy before its too late! …. ????? Seriously? No sir, I’m not buying it. Euphoric sugar highs from eating too much cotton candy (what the so-called “fundamentals” the bulls are pointing to right now) lead to really nasty and cranky crashes later on.
However I do foresee a stronger rally within the next year based on increasing fundamentals, but ultimately just a larger bear market rally. What I think needs to (and will) happen now is a pullback to shake out the unhealthy (weak-handed) bulls. I think this will set the stage for a much longer and stronger rally. Ultimately my belief is that the next rally after the pullback for the next 1-2 months is just another bear market rally. However I think the fundamentals will (slightly) improve for a time. And I think the rally will be (slightly) more fundamentally and technically sound, or more specifically: the fundamentals won’t stink quite as bad as they do right now. But at the end of the day it is just another bear market rally.
.... continued in the Comments section ....