Is the Bottom In?
By Jerry Slusiewicz | July 28, 2008 | 4:24 PM | 0 Comments
Have we bottomed out? The stock market was unable to build on the prior week's gains, but it wasn't for a lack of effort. Oil prices slipped almost 5% to $123 per barrel, the financial sector was up as much as 10.6% at its high for the week on the idea that Fannie Mae and Freddie Mac weren't going to be allowed to fail, and bank earnings news was generally better than feared.
The enthusiasm toward the financial stocks ended in a hurry on Thursday, when the sector dropped almost 7% and suffered its largest decline in more than eight years. The sector had gone too far, too, fast led to the reversal of fortune. From its high on Wednesday to its close on Friday, the sector dropped around 10%.
From my vantage point, the financial sector pullback should not have been seen as a surprise. The sheer magnitude of its short-term advance made it inevitable. (I had many comments that my last update came off really negative.)
As Paul Harvey once said, "In times like these it helps to recall that there have always been times like these." The world will not come to an end. The future will arrive. The cycles will continue. Winter will follow summer, spring will follow winter. For investors it's important to recognize that business, the economy, and markets also move in cycles, not just straight lines. Recessions follow boom times, bear markets follow bull markets, and bull markets follow bear markets. This time it will be no different.
However we have some issues to work through in the near term. And in the longer term it is important to recognize that the major market indices have made zero progress in 10 years. So buy and hold is not a sound strategy in this environment. It is important to use the three P's. A Plan, that allows Participation, and Protection.
Last week started off well enough but there was some bad news released about the housing market on Thursday. Mortgage rates surged up to an average of 6.77% for 30-year mortgages and foreclosures rose 14% more than double the rate of a year ago. Existing home sales, which make up 85% of the market, fell another 2.6% in June to a 10-year low, while the inventory of unsold existing homes rose to an 11.1 month supply, the 2nd highest level in 20 years. A total of 4.9 million homes (new + existing) sit on the market awaiting buyers. Meanwhile combined new and existing home sales volume is down nearly 40% from its July 2005 peak, with higher mortgage rates on the horizon.
More bad news came from the unemployment claims which jumped 34,000 last week. The Dow tumbled 283 points on Thursday. And after the close Friday, regulators announced the failure and FDIC takeover of two more banks. That makes seven failed banks so far, but I expect more to go before this cycle ends.
Now for some good news! It was reported that Durable Goods Orders rose 0.8% in June, their biggest gain since February. Much of the strength may be attributed to a surge in export growth over the last year, tying the fate of business investment more to the global economy than to US consumer demand. The University of Michigan Consumer Sentiment Index unexpectedly rose to 61.2 in July from 56.4 in June. While 61.2 is still a very low number the improvement was not expected.
According to Bloomberg, second quarter earnings, ex-financial, are tracking to be up 8.6% as opposed to down 18.2% when financials are included. Of the 248 S&P 500 companies that have reported their results, 72.2% have registered positive surprises, 4.8% have been in line, and 23.0% have missed expectations.
This week we have another heavy slate of earnings reports and a key batch of economic data including: Tuesday's Consumer Confidence Report, Thursday's Chicago PM Index & second quarter GDP estimate, and Friday's Monthly Jobs numbers for July, Construction Spending, & the ISM Manufacturing Index. The biggest news will be Thursday's advanced Q2 GDP report and Friday's July employment report.
The GDP numbers could have an upside surprise. There is enough data, including last week's stronger-than-expected durable orders report, to state that it is possible that second quarter real GDP could increase to close to a 3.0% annual rate. That's not only above the 2.0% level that is the current consensus forecast; it's also a long, long way from a recession.
So here we are at a potential crossroad. The housing crisis remains far from over and most financial institutions are still behind in facing up to losses. Was the rally of a couple of weeks ago just a byproduct of short covering? Or are the lows for this cycle in place? It's still too early to tell. Many technical factors point to the low being able to hold. The markets do discount in advance of the economy and much of the ongoing bad news could already be priced in. However I would like to see a higher low and a higher high in place from the July 15th low before making any fresh commitments of capital. Today's continued market selloff was on low volume.
Many thought we would see a panic selloff resulting in a capitulation in the market. We may have seen that in the financials, and in the high low index, but something just seems to be missing. It may be that there are still far too many optimists that haven't figured out how bad our economic situation really is. The Fed can't raise interest rates to battle inflation because that would kill real estate again (is that possible?). If the lower interest rates the US dollar will plunge even further, causing more inflation. So they are holding their breath and hoping things get better based on their previous efforts. More time is needed to see if they were successful and the July lows hold.
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