Just When You Think Things Are Bad—
The Market Gets Good!
by David Anderson
unforgiving task of pinpointing the exact starting and ending time of any
U.S. economic contraction.
Unfortunately, because reported data is frequently revised (and often many times) before it is anointed as being “final”, the precise demarcation of weakness generally must wait until after an extended period of analysis. Contrary to popular thinking, the NBER is not simply looking to find two consecutive quarters of negative GDP (gross domestic product) growth. In fact, the Bureau is reviewing reports to find declines in production, retail sales, income and employment. In any event, even though investors must make realtime decisions with less than complete knowledge, the stock market’s record of forecasting recoveries has been most remarkable. Without fail, in each of the ten post-World War II recessions, the stock market has bottomed approximately halfway through the periods of malaise.
Currently, the signs are becoming more and more evident that the U.S. economy did in fact enter its current downturn in late-2007. Dr. Ben Bernanke, in his semi-annual testimony before the Senate Finance Committee, indicated that the U.S. may be entering a period of weakness. Not to be outdone, Business Week had a cover article about the impending recession. The really good news, to a true contrarian, is that by the time these and other expert economists are willing to admit there just might be a recession, it is almost always a perfect time for the stock market to recover. Depending on what data one chooses to believe, the peak in business activity occurred somewhere between September and November 2007. And, if this recession is normal by post-War standards, it will have a duration of about eleven months. Therefore, under this scenario, stocks could logically be expected to bottom at the five-month point or, some time between February and May 2008. Thus far, it appears that the S&P 500 has double bottomed around the 1270 level (on January 22 and March 17) and while the latest rebound has been too limited to forecast that we are at the midway point in the cycle, the second low could prove to be more durable. Additional contrarian technical indicators that seem favorable in the short-term are: 1) Investors Intelligence now has more bears (41.1%) than bulls (36.7%), 2) the put/call ratio is above 1.0X, 3) mutual fund redemption activity is exceeding purchases and 4) the short interest volume on the New York Stock Exchange represents nearly 10% of all activity.
The recession has been real estate centric
and while the residential market has seemingly
been most impacted, the commercial market
normally follows closely behind. In any event,
there are still about 9-10 months of supply, or
nearly 4.5 million available living units (new
and used). Therefore, a longer than “normal”
recession must be considered. As an alternative,
if we consider that the current economic period
may be more akin to some of the debt-extended
recessions before 1945 (and after 1892), we must
grapple with the concept that the pre-1945
experiences lasted about 18-months (on average).
If this turns out to be a more likely outcome,
then the stock market should produce a triple
bottom sometime around July 2008.
Many would argue that the S&P 500, at 14x
consensus earnings, is attractively priced. However,
analysts’ aggregate profit expectations are
notoriously unreliable. As a recent example, late
last year it was expected that the 1Q-2008 consensus
S&P 500 earnings would continue to
moderate with year-to-year growth of about 5%.
Now, just as we are entering the reporting season
(note-Alcoa is considered the bellwether report
on April 7) the projections have been greatly
reduced to the point that most are anticipating,
as much as a 10% decline in earnings, due to massive
write-downs from financial stocks. 
David B. Anderson is Sr. Vice President & Chief Investment
Officer of Value Equity
Financial Counselors, Inc.
P | 816.329.1500
E | DAnderson@FCIAdvisors.com