Stocks have fallen broadly this month on intensifying credit fears, and now it’s getting serious. The broad market is now down 24% for the year and 30% from the last top in October 2007.
The good news in that, I suppose, is that the average bear market of the past 75 years has been down 40%, so it’s at least a good guess that we’ve only got another 10% to go as we wait for this conflagration of capital to burn itself out. That would be around S&P 960, which was the downside goal that I have proposed to subscribers about a year ago.
I’m sure that most of you have a lot of questions about what exactly is unfolding on Wall Street and in Washington now—but trust me, you are not alone. Most sophisticated investors from London to Beijing are just as perplexed as you, as are politicians and top government bureaucrats.
The topic is on the lips of everyone that I meet these days, from business meetings to youth soccer games. My kids say that teachers are even discussing the stock market and credit crunch in middle school and high school. It all reminds me of the Watergate hearings, which were the buzz for me in high school in 1974—the topic of every conversation everywhere, and the center of our American history class.
Fortunately, as InvestorPlace.com members, you have been among the most informed throughout these amazing times. And now hopefully I can help shed some more light on what’s happening.
Stock Demand Weak
First let’s look at what we know as investors, and then move forward. I have recommended that Trader’s Advantage subscribers maintain a defensive posture toward stocks over the past ten months because the S&P 500, our proxy for the market, crossed emphatically into a bear market at the end of December 2007.
In a bear market, there are always a few winners but there are mostly losers. It is really hard for the broadest swath of stocks to evade the bears’ wrath. (See also: "Users Manual for a Bear Market.")
Moreover a mentor once told me that "bad things happen in bear markets," and he was right. A negative mood on stocks seems to cause or coincide with unfortunate social and political change, with the most recent being the terror attacks during the 2001 bear market. And now a crisis that began in credit markets 15 months ago, then spilled over to the stock market, has reverberated back to the credit markets with a speed and intensity unparalleled in the past 50 years.
My recommendation has been that you…
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My recommedation has been that you maintain at least 60% of your investable funds in cash or cash equivalents, which is a much higher allocation that most financial advisors ever suggest, and that you use even my own stock recommendations sparingly. As the sour market has intensified since July, there has been virtually no sector in which to hide, and even bear market strategies have proven difficult, with the most egregious example being an abrupt ban on the short selling of almost 1,000 stocks a couple of weeks ago.
The best way to escape the firestorm is by sticking with a coldly calculating statistical approach, so let’s look now at what the numbers are saying.
No Panic Selling of Common Stocks
Banks like Morgan Stanley (MS), Goldman Sachs, and Northern Trust (NTRS) saw shares drop by more than a third in a few hours on high volume, and then recover. The next day, authorities banned short-selling of financial stocks and the market put in a 700-point advance in the Dow Jones Industrials (from bottom to top) that looked for all the world like one of those terrific 90% Upside Days that I have written about.
But now after looking more closely at the numbers even then there was reason to pause. Keep in mind that really important bottoms occur only at times of intense, panic selling that exhausts the desire to dump stocks. As Paul Desmond at the institutional firm Lowrys Reports points out, if selling is not exhausted then any rallies will be met by a new rush of selling and buyers will be quickly swamped.
Many technicians have said that September 17 did amount to that type of panic selling, as 1,238 new lows were recorded that day on the New York Stock Exchange, or 37%, the biggest number in a decade. Yet that number was a bit deceiving. You see, a bit more than half of the 3,353 securities listed on the NYSE are preferred stocks, which act like bonds; closed end bond funds; and ADRs that don’t reflect the U.S. market very well.
To get a better sense of new lows, you need to study a version of the NYSE that looks only at U.S. operating companies, which total 1,587 now (and shrinking all the time, unfortunately). Looking at that group, the number of new lows was 272, or just 17%, which was pretty mild even compared to recent temporary bottoms in January, March and July of this year. This suggests that, sure, there was a panic in bonds and preferreds, but common stock holders did not really panic.
The selling on Monday, meanwhile, was definitely intense—but volume was amazingly low. This all suggests that selling has not been exhausted, as it would be in a real market bottom—and so we should continue to be skeptical and defensive until more evidence emerges that a sustained advance is ready to begin.
Perhaps that evidence will come this week, or over the next month. We can always hope. And in the meantime, we can trade as you will see at Trader’s Advantage. Come take a look.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com and check out:
