Accelerated Panic Levels in World Markets

We are finally going to see capitulation ... something the market, Wall Street, and the pit traders have been waiting for.

Extreme capitulation occurs in a progression where investors move from optimism & denial to fear, fear to panic, and then panic to despair. We should now see the despair stage where investors try to bail out at any costs.

This will cause more forced redemptions on Hedge Funds and Mutual Funds. The current accelerated process could last for 3 days before the selling is exhausted.

At the same time, credit default swaps and highly leveraged positions are being unwound. This all adds to the panic level and it squeezes the liquidity out of the markets. Peak liquidation levels are likely to occur between today and Tuesday.

The market has tried to establish a few rallies in the past days but has not been able to hold on to any of them. Part of the reason for this is that there has been substantial selling pressure from hedge funds facing redemptions. Until that pressure dissipates, the markets will not be able to find a rally that holds for any amount of time.

It is going to take time for all of the economic problems to unwind and resolve themselves. Leveraged investments have to be unwound. Liquidity has to start flowing again, and banks have to start lending (Currently, 1 in 4 new car buyers with excellent credit are being refused a loan). Central banks have to act more aggressively and get the liquidity to flow again ... they are trying to do that now.

Meanwhile, the stock market discounts recessions and the future in the present. As that happens, fear and panic selling causes the market to overshoot how far down it should go. That gets compensated with up moves that brings the stock market closer to a real fair value ... so rallies have not gone away forever. They will be back ... and we are likely to see some pretty good ones after extreme oversold conditions.

Inflation Drop & Market Impact

A combination of a higher U.S. dollar and Japanese yen, the vortex of selling and unwinding of long commodities positions (by pension plans and endowments, corporations, hedge funds and managed commodity funds) and renewed evidence of a deepening recession have served to accelerate the decline in commodity prices.

Remarkably, the CRB Index, which includes energy product prices, is now back to its late 2004 level. The CRB Raw Materials Index, which excludes energy product prices, is back to its level last seen in summer 2006.

In the aggregate, the energy, materials and related sectors only account for about 25% of the S&P 500's profit, so the remaining 75% of the S&P is poised to benefit from the cost relief associated with lower commodities prices. This, combined with the continued tame year-over-year change in unit labor costs (of around 1%), will produce a marked deceleration in headline and core inflation.

While the outlook for top-line revenue growth in 2009-2010 remains problematic, the above cost trends will, in the fullness of time, act as a headwind to a sharp mean regression in corporate profit margins.

For now, a bull market in fear, concerns regarding a "Great Recession" and the continued indigestion in the hedge fund and fund of funds industries remain front and center. Over time, however, the basis of an improving intermediate-term market picture seems likely to reassume center stage based on the following considerations:

1) Inflation is ebbing.
2) The Fed is and will remain market-friendly.
3) The credit markets are thawing.
4) Fiscal stimulus appears on the way.
5) Financial institutions' capital bases are being shored up.
6) Stock valuations are subdued.
7) Investor sentiment is at record negative levels.
8) Forced selling by executives, individuals, and hedge funds has historically marked a market bottom.

Color me uncertain about the market's near-term outlook but more bullish about the market's intermediate-term outlook.

S&P 500: Which Way Will it Go?

The S&P 500 index is now trading at the low end of its recent triangle formation. Investors with a technical bias will be watching to see if this level holds in order to determine whether the recent decline is a successful test or the beginning of another leg down.

From Credit Crisis to (Cold) Economic Reality

Optimism on the coordinated actions of the European Union countries and U.S. to inject capital into banks (Dow up 1800 points from it's 5 year low on Friday) has led to the cold hard reality of a strong, potentially deep global recession (Dow down 1200 points from it's recent high this Tuesday morning) causing second thougths on the value of holding on to stocks. Reality is also sinking in that the various banking interventions, albeit very significant in scope and magnitude, will take time to kick in and have favorable impacts. In the interim, uncertainty rules.

Expect the see-saw to continue, and potentially for a re-test (and dive below) last week's lows. Earnings will continue to stream out over the next few weeks. Attention will be focused not so much on the rear view mirror (3rd quarter earnings) but the windshield and the outlook ahead. Buckle up...

Signs of a Short Term Bottom?

Several key money managers have recently voiced opinions that we might be at a short term low. While who knows where the wind will blow next, their perspective and experience adds some interesting context on the "behind the scenes" activity which frequently shapes the headlines and activity we see in the markets; it should be noted that both managers were bearish and called the market decline with scary precision...

Leon Cooperman, renowned hedge fund manager at Omega Advisors says "The bulk of the damage is done."

Doug Kass, founder and manager of Seabreeze Partners Management, notes heavy hedge fund shorting of S&P 500 futures contracts is often a contrary signal of extreme pessimism, and often can lead to short term market rally opportunities. We shall see...

Human Psychology and the Market

"What’s happening is people are crawling into a bunker and pulling an iron sheet over their heads because they think the sky is falling." - William Ackman, Pershing Square Capital

Buy on the Rumor, Sell on the News

Today proved a popular adage on Wall Street...institutions bid up stock prices in the morning on hopes of passage of the rescue/bail-out bill (the Dow was up 250 points)...then stocks were sold off after news of the bill's passage came out (Dow closed down 150 points). Reality is setting in, traders realizing this crisis won't be resolved with the passage of the bill.

The next phase for the market? Corporate earnings start coming out over the next few weeks. Currently, the market is discounting an annualized trend-line of $70/share earnings for the S&P 500 (as compared to $90+ during the peak in 2007). There is a risk to stock prices if earnings (and, most importantly, forward looking expectations) come in at a lower run rate.