Monday, October 13, 2008

Buy, Mortimer, Buy!



U.S. stocks staged the biggest rally in seven decades on a government plan to buy stakes in banks and a Federal Reserve-led push to flood the global financial system with dollars:

The Standard & Poor's 500 Index rebounded from its worst week in 75 years with an 11.6 percent advance, its steepest since 1939, and the Dow Jones Industrial Average climbed more than 936 points. Morgan Stanley soared 87 percent after sealing a $9 billion investment from Japan's Mitsubishi UFJ Financial Group Inc. Alcoa Inc., Johnson & Johnson, Chevron Corp. and Prudential Financial Inc. posted their biggest gains since Bloomberg began tracking the data. Europe's benchmark index climbed 10 percent, its best jump ever, and Asia's added 3.1 percent.

``The worst of the immediate danger is past,'' said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, which manages $30 billion. ``It's always easier when you've got markets going up and you're not having to talk clients back in off the ledge.''

The S&P 500 rose 104.13 points to 1,003.35. The Dow increased 936.42, or 11 percent, to 9,387.61, eclipsing its previous record 499-point gain in March 2000 and posting its best percentage advance since 1933. The Nasdaq Composite Index climbed 194.74, or 12 percent, to 1,844.25. Sixteen stocks gained for each that fell on the New York Stock Exchange.

The S&P 500 halted an eight-day losing streak, its longest since 1996. Last week's 18 percent declines pushed both the S&P 500 and Dow down more than 40 percent from their peaks last October. The S&P 500 ended last week trading for 17 times reported earnings of its companies, the cheapest valuation in more than a year.

...

Today's rally boosted the index's price-to-earnings ratio to 19.2. The S&P 500 is still down 32 percent in 2008, poised for its worst yearly loss since 1937.

All 10 industries in the S&P 500 added more than 7 percent. The rally from Tokyo to New York sent the MSCI World Index up 9.5 percent, the biggest gain since the gauge was created in 1970.

Some 1.5 billion shares changed hands on the floor of the NYSE, less than 1 percent more than the three-month daily average. The bond market was closed for the Columbus Day holiday. The dollar fell the most in three weeks against the euro.

So the big question now is this another sucker's rally or time to buy? I quote the following:

On the heels of the worst week in history, the prevailing wisdom on Wall Street is the stock market is now cheap, especially relative to Treasuries and most especially for long-term investors,

With the S&P trading at 13 times expected 2009 earnings and 17.2 times on a trailing P/E basis, "buy the dip" is the mantra from many observers:

  • "The sell-off has gone much too far and stocks are poised to rally powerfully if the downturn is less severe than investors," according to The New York Times.
  • The "Ben Graham P/E" - which divides the price of stocks by their inflation-adjusted net earnings average for the past 10 years - is the lowest its been since 1989, The WSJ reports.
  • Even typically skeptical observers like Barron's Alan Abelson and FusionIQ's Barry Ritholtz were writing this weekend about the potential for a short-term market bounce of between 20%-30%.

That message, along with news of the U.K.'s injection of capital into big banks and Mitsubishi UFJ's investment in Morgan Stanley, helped the U.S. stock market rally strongly early Monday, following the path of global proxies.

I would caution against reading too much into Monday's action: the bond market and U.S. banks are closed in observance of Columbus Day while Japan's financial markets were also closed for holiday observance.

More importantly, I'm highly skeptical Friday marked anything more than a temporary bottom for stocks, for a variety of reasons:

  • The continued lack of a coordinated global policy response, and the U.S. continuing to lag other nations in taking the most dramatic steps like insuring all bank deposits and directly injecting capital into banks.
  • Accelerating weakness in the "real" economy; ISI's Ed Hyman dramatically reduced his GDP estimates through the second half of 2009 and predicts unemployment will hit 8.5% before the cycle turns.
  • Valuations tend to overshoot on the downside and bear markets historically don't end until P/E ratios hit single digits.
  • Even after devastating declines in recent weeks, "buy the dip" remains the conventional wisdom, meaning sentiment still remains overly optimistic.

"The past week has demonstrated that trying to buy 'close' to the bottom of a bear market can be a very dangerous strategy," Lowry's Reports commented this weekend. Last week's "series of 90% down days" - trading sessions where 90% or more of both price action and volume is to the downside - "is, at this point, solid evidence that the desire to sell has not been exhausted."

Veteran market watchers like Art Cashin of UBS and John Roque of Natixis Bleichroeder are using the 2002 lows - about Dow 7300 and S&P 775 - as downside targets.

I happen to think that this powerful rally will have legs but I am still curious to see how we close tomorrow (I expect profit taking in the morning but I want to see if fresh cash comes into the market).

One thing I do know is that hedge funds are still performing miserably, stock mutual funds are no better, and Canadian pension funds took their worst hit in ten years (same for global pension funds).

What does all this mean? I suspect institutions will be buying this sucker as much as possible heading into the end of the month. They need to make up for lost ground.

Make sure you read yesterday's commentary, Beyond the 2008 Stock Market Crash. I took the time to research what hedge fund and mutual fund managers were buying during last week's savage selloff.

Also, I highly recommend you read John Mauldin's latest Outside the Box commentary, Why the Worst Will Soon Be Over.

Finally, John Hussman's weekly comment, Four Magic Words: "We Are Providing Capital", is excellent and provides lots of food for thought.

***Morning update (14-10-08):

World stock markets soared and the U.S. Treasury announced it will invest about $125 billion in nine of the nation's biggest financial institutions, including Citigroup Inc. and Goldman Sachs Group Inc., as part of a $250 billion effort to shore up the banking system.:

``We're looking today at an absolute sea change in the global financial system in terms of liquidity,'' Stephen Schwarzman, chief executive officer of Blackstone Group LP, the world's biggest leveraged buyout firm, told a conference in Dubai today. ``This could be the time that breaks the back of the credit crisis.''

The Treasury plans to spend $25 billion each for stakes in Citigroup and JPMorgan, people said. Another $25 billion will be divided between Bank of America and Merrill, which agreed last month to be acquired by Bank of America. Wells Fargo is to get at least $20 billion, Goldman and Morgan Stanley will each get $10 billion, and State Street and Bank of New York will get about $3 billion each, people said.

Also, read this Bloomberg article, Hedge Funds Concede Errors, Profess Optimism After Worst Losses:

``We clearly underestimated several things, most importantly the tsunami of redemptions that are being delivered to hedge funds as investors line up to get out of these funds as well as record outflows from equity mutual funds,'' Jeffrey Gendell, who runs Greenwich, Connecticut-based Tontine Associates LLC, wrote in an Oct. 1 letter to clients.
Those of you who want to understand what all these bailouts mean, I suggest you read Michael Hudson's excellent article in Counterpunch, Rescue for the Few, Debt Slavery for the Many.

**Lunch comment:

While some are still discussing whether this was the bottom, the Financial Ninja says this rally is the real deal. When it comes to market movements, don't mess with this ninja...BUY THE DIPS!

***Late afternoon plunge:

Yikes, the Dow is down almost 300 points! Let's see if we hold the 9,000 level. Keep an eye on the last half hour of trading to see if traders start buying again.

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