By Capital Multiplier | 27 January 2008
| Clearly, we have now made several of the most spectacularly successful market calls of this decade as seen from the following: |
1) Bank of America posted a 95% decline in quarterly profit after suffering a $5 Billion write down in the value of its mortgage holdings,
2) Wachovia Corp. announced a 98% decline in quarterly profit after taking a $1.7 Billion write down for loan losses,
3) E-Trade Financial reported a net loss in its latest quarter after losing $2.2 Billion on the sale of its portfolio of mortgage debt, and
4) After peaking last October, the Dow Jones World Index has been plunging lower reflecting the sharp drop in global stock markets. Indeed, according to a Bloomberg report, 43 of the world's biggest stock indexes fell into Bear market territory last week, representing a decline of at least 20% from their 2007 highs! Now you know why we repeatedly warned you not to believe Wall Street's nonsensical claims about 'global decoupling' and foreign markets being immune to a U.S. economic recession!
So how did U.S. policymakers respond to last week's global market plunge? The Federal Reserve resorted to an inter-meeting rate cut and slashed the Fed Funds rate by 75bps (the biggest interest rate cut in more than 2 decades)! And the U.S. Congress announced a $150 Billion 'economic stimulus' that would give most tax filers rebates of $600-$1,200 (and more for those with children) and raised the limits on Federal Housing Administration loans and home mortgages that Fannie Mae and Freddie Mac can purchase to as high as $725,000 in over-priced markets like NY and CA.
Global stock markets immediately bounced after the Fed's rate cut but there was no follow through and the S&P 500® rose just 0.4% last week. So now that U.S. policymakers have clearly shown that there is no limit to their stupidity and that they are willing to 'prop up' asset markets, Wall Street cheerleaders are once again declaring that stocks have 'bottomed'. Indeed, many analysts are calling for a significant market rally citing factors like good stock Values, Oversold Markets, and Investor Sentiment as probable catalysts.
We think they are wrong because: Values: Wall Street proponents of the 'Fed Model' are pointing to the 3.5% yield on 10-Year U.S. Treasuries as bullish for the stock market. However, our research shows that over the past several decades the Fed Model has proven to be a very unreliable tool for timing market tops and bottoms. Also, contrary to popular perception, we believe the stock market is currently overvalued based on most fundamental valuation metrics because Wall Street's 2008 earnings estimates for the S&P 500® are ridiculously over-optimistic. According to Wall Street consensus estimates, analysts are projecting S&P 500® earnings growth of nearly 15% this year ostensibly driven by very strong comebacks in the Consumer Discretionary and Financials sectors!
Given our expectations of: i) A global economic slowdown (possibly a global recession), ii) Further sharp declines in real estate prices in U.S., U.K., Spain and many other countries, iii) A significant correction in commodities, and iv) Further huge losses for global financial institutions at least this year and next, we think we will be lucky to see no significant losses in earnings.
Oversold Markets: In a Bear market, the market can get short-term 'oversold', bounce a little (and not even to a positive reading, e.g., see Tuesday's market 'rebound') and then market prices can continue to plunge through so-called 'support levels' without pausing!
Investor Sentiment: Recent surveys of individual investors have shown a huge jump in bearish sentiment which is considered bullish from a 'contrarian' standpoint since high readings of investor pessimism generally occur near market lows. However, given the fact that nowadays individuals account for only a quite small percent of daily trading volume, we believe their actions are likely to have only a marginal impact on market prices at best and that their sentiment is not much reflected in today's 'computer driven program trading'. We have seen no signs of the 'panic' selling by institutional traders or individual investors that typically occurs near market bottoms (aka, the 'great washout').
Most investors seem to be as yet unaware that the eventual magnitude of capital losses suffered as a result of the U.S. housing and mortgage debt crisis alone by global financial institutions is likely to be several times that of the Savings & Loans crisis of 1990 (which, moreover, had little effect on homeowners, except that they were shielded from run-away interest rates during a period of run-away inflation— it was the S&Ls that went bankrupt). To make matters worse, it is only the tip of the iceberg, there are trillions of dollars in highly leverraged, high-risk LBO loans, ABCS, RMBS, CMBS, and a zoo of other paper 'assets' that have already started declining sharply in value, exposing global financial institutions to further huge losses this year! There are ABCBs which were rated triple-AAA for the highest rating that no longer even trade, i.e., their value has gone to zero!
Given that the relatively much smaller S&L crisis of the early '90s was enough to push stocks into a cyclical bear market, we really don't think it will be possible for the Federal Reserve and Wall Street to prevent a minimum bear market decline of at least 20% in the S&P 500® by sometime this year (we are almost there already). That gives a minimum downside target for the S&P 500® of 1250. So we are not making any changes to our Model Portfolios at this stage. However, if you believe you are over-committed on the bearish side, we suggest taking appropriate precautions immediately, since we may be heading into a (limited) counter-rally around here.
Normxxx ______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only. The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
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