by: Chris Ciovacco
October 11, 2009
As investors try to make sense out the of relentless bullish moves in asset prices, we will touch on a few timely topics:
* Is the Fed about to raise interest rates?
* What signal is gold possibly sending?
* Are bonds and gold telling us to sell stocks?
* Are stocks about to crash like 1987?
The Fed: Actions Speak Louder Than Words:
Market participants better prepare for much jawboning from the Fed in the coming months. This from a October 9, 2009 Bloomberg story:
The Fed will need to raise rates "at some point" to control inflation, Bernanke said at a Board of Governors conference yesterday in Washington. Experienced market participants know that with unemployment high (and rising) and excess capacity to be found in every corner of the economy, the Fed is nowhere near a point of raising rates significantly, if at all. They may hike in a very minor fashion sometime in the next year, but talk of significant increases will be just that – talk. What do we expect the Fed to say? The Fed Board of Governors has decided to never raise rates again because we need to reinflate asset prices to help repair balance sheets and restore some of the lost "wealth effect"?
Gold's Move Supports Higher Asset Prices:
After failing to do so since March 2008, gold finally was able to break the 1,034 barrier this week. If you want stocks and commodities to go higher, then you want gold to go higher as well. Why? Because a major objective of all the money printing, government intervention, and low interest rates is to create positive inflation, which includes asset price inflation. Asset inflation helps heal sick balance sheets and repairs a portion of the lost "wealth effect". When gold lies dormant, it means reflation is not working all that well in the minds of market participants. Gold’s recent breakout may indicate that the entire reflation of assets is working (in the minds of market participants - they fear future inflation caused by money printing, intervention, etc.). Asset prices need positive inflation (rather than deflation) to move higher. Risk/weak dollar/reflation assets need gold to move – it is – and that is a good sign for most markets.
Chart 1 (click to enlarge)
Stock Market Performance After Recessions:
On September 15, 2009, Federal Reserve Chairman Ben Bernanke said the current recession is "very likely over." What Chairman Bernanke is referring to is the end of the "GDP recession", which means we could be seeing positive GDP numbers from the current quarter. It does not mean everyone has a job, job security, and generally feels good about the future.
The analysis below is based on the end of a "GDP recession", which probably occurred sometime in July 2009. Regardless of how people felt in 1949, 1954, 1958, 1961, 1970, 1975, 1980, 1982, and 1991, the average path stocks took in the two years following a recession’s end was quite positive (see Chart 2 below). In 2009, this tells us odds favor higher stock prices in two years. Whether or not that happens remains to be seen, but the charts remain in a bull market as of the close on Thursday, October 8, 2009.
As depicted in Chart 2, the two-year period following the end of recessions tends to produce favorable investment outcomes for investors. In nine out of the last ten cycles when recessions came to an end, the stock market had already climbed above its 200-day moving average giving technical confirmation to an improving fundamental outlook (the exception was 2001). Point B in Chart 2 would hypothetically occur in July of 2011. Point A corresponds to July 31, 2009 (hypothetical end of recession). Chart 2 shows the mass psychology of investors as they shift from fear (during the recession) to greed (after the recession).
Chart 2: Shift In Mass Psychology
With 2009 year-end approaching fast, Table 1 shows the market’s performance during the first five months following the end of a recession. If we assume the 2009 recession ended on July 31, 2009, five months would correspond with December 31, 2009.
Table 1
1987 Does Not Compare Well With 2009:
While no one can predict the future, we can study the past in order to get a better understanding of how greed and fear can impact financial markets. People have been greedy and fearful since the beginning of time, which means they tend to act in similar ways from generation to generation. Many market observers are saying stocks are about to crash in 2009. We have studied every bull and bear market cycle since 1929. We see very little reason to believe that a stock market crash is imminent, based on what we know as of October 8, 2009. However, it never hurts to examine bearish turns since we may learn something that may help us spot trouble in the future.
We have covered other bull and bear cycles in previous articles and in CCM research publications. We have not previously covered 1987 since it does not compare well to the present day. When stocks made lows in early March 2009, a serious and painful "waterfall" bear market had just ended. Therefore historical cases of investor's reactions after "waterfall" bear markets best capture the circumstances of investor greed and fear as it relates to the present day. As shown below, investor’s level of confidence was quite different in October of 1987 after two years of gains vs. today where going two years back buy-and-hold investors are still sitting on big losses. Sentiment is a big driver of investors' actions.
Charts A & B (click to enlarge)
While quite busy-looking, the moving averages in the charts below can help us better understand the potential staying power of a market’s trend. In 1987, stocks experienced a significant correction between late March 1987 and late May 1987 (see Peak A-1987 in Chart C below). Peak B-1987 turned out to be the last hurrah before the crash. We have shown recent peaks in 2009 for comparison purposes (Chart D below). Our focus is on how the moving averages interact with each other and how they interact with price. Chart D is as of October 7, 2009.
Charts C & D (click to enlarge)
Below (Charts E & F), we are zooming in on Peak A in 1987 and on Peak A in 2009. The moving averages in the Peak A -1987 graph show an extended market that looks due for a correction. Peak A in 2009 does not look similar to the extended state of Peak A in 1987. Peak A in 2009 occurred in June only three months after a “waterfall” bear market – hence the market was not nearly as stretched as it was in April of 1987, when Peak A-1987 occurred.
Charts E & F (click to enlarge)
Peak B-1987 (Chart G below) also shows an extended market – note sharp rise of the 20 and 30-day moving averages (blue and red lines in top graph / Chart G). Peak B-2009 (Chart H below) also represents an extended market, which did ultimately lead to a correction. However, the distance between the 20, 30, and 40-day moving averages (blue, red, and green lines in 2nd graph below) is more compact, representing a market which was a little tamer compared to Peak B-1987.
Charts G & H (click to enlarge)
1987- Market Did Raise Some Red Flags:
The two charts (I & J) below show 1987 pre-crash (top) and post-crash (bottom). On Peak B-1987 notice how the 20-day (blue) pulled away from the 30-day (red) and then broke back down sharply (steeper slope than Peak A-1987). When looking for signs of something more than a correction within a normal uptrend, you look for something that has not happened before (such as a break of the 120-day and a larger percentage decline - see notes on Charts I & J below).
The differences can be triggers to start controlling risk (a.k.a. doing some selling). The worse it gets and the further it moves outside the realm of a normal correction, the more you should sell. Sharp declines (almost vertical) warrant more selling. You can make better decisions by studying recent corrections in the market. If the current correction looks like recent corrections, you can stay the course.
Charts I & J (click t
o enlarge)Markets Remain Bullish, But Need To Be Monitored:
The technicals (charts) and fundamentals (improving economic data, post recession history, gold's move, etc.) continue to favor the bulls. Until we see technical evidence to the contrary, we will assume we will get more of the same - bullish outcomes and higher highs.
As always, we need to be ready to play defense should conditions change. "Monitoring The Health Of The Bull - Red Flags", which acknowledges the risks associated with blind investments in the current environment, can help you with some possible red flags to look for (see Page 20 of the most recent Asset Class Outlook.) Many problems remain - be careful.
Investments or strategies described above may be inappropriate for some investors based on their own individual situation and risk tolerance.
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