Be forewarned. There will be major disappoinments ahead. I gave you a timely advance warning of this recession, as well as its pernicious nature and, most recently, an advance indication of the current bear market rally from its 666 S&P 500March 9 low point. I also indicated the probable size of the rally, to 875, just shy of the 879 level indicated by a 32% rise to roughly return that S&P 500 index back to its 200-day trend moving average. Now, with the S&P-500 index closing up at 869.60 on Friday, I am giving you an advance warning of an imminent new bear market nosedive that will at least retest the early March lows or, more likely, set new equity market lows. That will prompt new buying of Treasuries and renewed significant declines in yields. For example, the Treasury ten-year note yield at 2.95% on Friday, should decline to at least 2.5%.
These are far from consensus views. Instead, there is unjustified market confidence that the equity market is in a sustainable rally. For example, Ken Fisher, Chairman of Fisher investments expects the S&P 500 rally the past six weeks to be extended, from 870 currently to 1130, another 30% rise, by March 2010. Such views typically stem from an unwarranted hope that the economy is bottoming out, that the credit crisis has been resolved, that the banking system has been mended and that inflation is about to emerge, producing a renewed surge in commodity prices. In German there is an expression which to my way of thinking aptly applies to such views. It loosely translates into living on cloud nine cookooland. In other words, in my opinion, such views are nonsense.
The reality, as I see it, is that the equity market is vulnerable to a renewed and very steep decline. The economy remains mired in a deep recession. Despite the various Fed and Federal government efforts to provide assistance to the credit market and financial institutions,the credit crunch continues in full swing. Banks are still beset by pronounced losses that compomise their capital and restrain their lending. Deflation is already in evidence and is likely to worsen for an extended period. further undermining corporate profitability. That ever more onerous deflation pattern will, of course, keep the threat of inflation from being realized any time soon, most likely for years. A closer look at the forces at work should make the reasons for my views in each of these areas self evident.
The equity market has moved from being oversold at its early March low to being more than fully priced currently. The S&P 500 for example, has a projected income per share of some $40 this year. Even that level could yet prove optimistic. But, at $40 per share, current S&P 500 price levels translate into a price-earnings ratio level of almost 22, an excessively high level at any time and especially in the midst of the worst recession since the 1930s. One of the major driving forces of the rally the past six weeks was undoubtedly short covering, not a projected or realized recovery in earnings. But, now the sizable short position underpining of the rally has been substantially reduced. April is a seasonal period of rising equity prices, while May often ushers in a period of lackluster or disappointing equity price performance. That pattern even in more normal times helped create the dictum of sell in May and go away. That is likely to prove even more prescient than usual coming off a spectacular but unsustainable March-April equity market rally.
It was precisely the various market factors that caused me to predict a major bear-market rally before it ocurred in early March, that, having flip-flopped, now incline me to warn of an imminent reversal of the rally, probably beginning in May, if not before. Extremes of equity market overbearishness has reverted to overconfidence, unjustified overconfidence. The trigger for a renewed decline could be the 6% or so plunge in first quarter real GDP, to be released later this month. Other potential adverse market catalysts include a near 700,000 drop in April nonfarm payrolls and another sharp rise in the unemployment rate to be reported in early May, as well as disappointing corporate or financial institution earnings or the results of the bank stress tests, also to be released in early May, despite the rumored Treasury intention of giving them all a favorable review.
I am not alone in my negative view. A Morgan Stanley analyst went so far as to recommend selling "before it is too late" and Goldman Sachs' decision to issue stock this past week can be seen as a vote of no confidence in an extention of the rally.
The various presumed postive signs of impending or actual economic recovery are fanciful or due to inappropriate seasonal adjustments. This week, for example, initial claims for unemployment benefits fell 53,000 to 610,000 in the week ended April 11. But, that improvement may reflect nothing more than a good Friday holiday shortened week in a volitile series. Other presumed signs of recovery are equally misinterpreted. That is certainly true of supposedly favorable data for housing, which continues in deep distress.
Indeed, a new speed-up of home mortgage forclosures has begun. How can this be happening, especially when a rise in forclosures is not only counterproductive to the effort to stem the drop in home prices, it is contrary to the thrust of the Administration's intentions? It arises because a number of financial institutions have terminated their self-imposed temporary moritorium on forclosures. For example, J.P.Morgan Chase, Wells Fargo & Co., Fannie Mae and Freddie Mac have all reported an increase in foreclosures as their foreclosure moritoriums ended. Though there is still an array of different approches to delinquecies by mortgage holders, on balance, forclosure filings are up sharply. In February, the latest month for which data are available, foreclosure filings were up almost 6% from January and 30% from February 2008. Moreover, foreclosure sales are also rising, as are long-term delinquencies 120 days or longer, a precurser to foreclosure. To make matters worse, mortgage problems are increasingly cropping up in FHA conforming loans, not just in sub-prime loans, as the recession widens its depressing grip. The process of rising delinquencies, foreclosures and forclosure sales will continue to depress home prices as the overhang of unsold homes available for sale not only remains excessive but is destined to rise further. Given persistent housing distress, it is not surprising that housing construction fell 10.8% to an annual rate of 510,000 units, less than one quarter of the more than 2 million peak pace in 2006.
This past week the CPI was down 0.4% in the 12 months ended in March. This is the first such year over year decline in more than a half century. The decline in consumer prices now joins the declines in producer and commodity prices. This deflation pattern is likely to persist in view of the US and global excess of labor and productive capacity, which tends to keep prices for goods, services and commodities under downward pressure.
Despite some favorable bank and financial institution earnings reports, credit losses will persist. The wide yield spread on loans will have to persist for an extended period of time to create earnings sufficient to offset the losses on mortgage related paper, as well as the increasing problems with commercial real estate and consumer and credit card debt.
The bottom line is that there is still a distressing array of economic and financial negatives to contend with that will take a considerable length of time to resolve.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
My email address is philipbraverman@Gmail.com
You can access this and prior weekly reports by going to internet explorer and typing the following internet address: philipbraverman.blogspot.com
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