Monday, January 5, 2009

Technical Market Outlook

The above chart of the S&P 500 averages is from

A review of it explains why I believe the long-term technical configuration of the stock market argues either for extreme caution or outright bearishness.

This blog will delve into market history and analysis more in the future. For now, please consider the following: The stock market made a bottom in the spring of 1942, when war fortunes were at their low ebb. Another important bottom was made in the late 1940s, but at a much higher level than in 1942. However, the fundamentals were drastically better in the late 1940s: we won the wars in the European and Pacific theaters, and were (as we learned in retrospect) poised to reap the spoils. In any case, the market began a more or less steady up-move from the late 1940s, and started from a public position of revulsion. All responsible people "knew" that bonds and not stocks were the right long-run choice. Follow the waning of upward momentum through the early-to-mid 1960s. Then note the about 17-year stretch from 1965 through 1982 in which stocks went nowhere, despite high inflation. Then note the unstoppable upward momentum of the averages from 1982 onward. Even the severe recession of 1982 was associated with relatively minor downward movement of the averages- a clear waning of downward momentum compared with the also-severe recession/bear market of 1974. As the bull market aged into the 1990s, upward momentum got frenzied through the late 1990s.

What we see after the 1999-2000 peak is increasing momentum on the down-move from 2000-2002/3; waning upward momentum on the up-move through mid-to-late 2007, and sharper downward momentum in the current down-move than in the 2000-2002/3 down-move.
The 2007 top in the market roughly equaled that of 2000, but adjusted for inflation and the minimal dividend yield vs. the high rates in T-bonds/bills available in 2000, stocks were an inferior buy than bonds. All sorts of long-term uptrend lines were broken in the 2008 down-move. All the relevant long-term moving averages have now turned down.

Thus we have the following situation:

The intermediate-to-long-term market chart stinks. The fundamentals of the economy stink. The Government is fighting the results of an over-leveraged economy primarily with leverage, which is illogical. The best prognosticators, ranging from famous ones such as Nouriel Roubini to superb bloggers such as Mish, are much more downbeat than the Establishment economists.

In my opinion, Federal Government securities are fundamentally risky but will be treated as risk-free at least for the foreseeable future. Amongst them, Ginnie Mae mortgage-backed securities have full faith and credit of the Government and yield about what riskier Fannie/Freddie MBS's yield. As a ratio of T-bond yields, Ginnies are at extremely undervalued levels. Vanguard and Fidelity have Ginnie Mae funds with similar long-term results: VFIJX and FGMNX. Both are at highs but can go much higher.

If you want to speculate, for taxable accounts, buy high-grade municipal bonds and for tax-deferred accounts, consider ultra-high grade corporates- but only when panic returns to the stock market. Right now, almost anything that costs a significant amount of money is in oversupply and is therefore deflating in price. Keeping your money in a CD or T-bill at even no interest at all will buy you more of that sort of big-ticket "stuff" than it will this month.

The stock market dropped over 22% one day in 1987 in correcting a massive up-move from the 1982 bottom (almost a quadruple of the averages in only 5 years). The averages also dropped over 20% one week in October in a structural bear market. That 20% weekly drop in 2008 was a bigger weekly drop than the week that contained the 22+% daily drop in 1987. The averages could do the following at any time: drop 20% in a day, and end the week down an additional 20% for a 40% weekly drop. Remember that the headlines that preceded the 1987 record drop were not especially scary. In these truly parlous times, new record moves in the averages are possible. So investors who really can't afford to lose much money shouldn't worry if the averages move up another 10% or more. Wait till the charts and the fundamentals look better, then wait for scary headlines that truly are old news or have little to do with economic fundamentals. Then the sharks will be gone from the water and you can make money with reasonable safety in stocks. For now, don't even think about it.

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