24/7 Wall St.

Everyone keeps asking why the stock market selling persists, yet they are the same reasons that were there in the weeks and months before the election.  The difference today is that now the election result is known we are in a price stability environment rather than an inflationary environment.  We at 24/7 Wall St. have maintained that we have been in a recession since basically the end of Q1-2008.  Sure, there was still official growth because we had a mini stimulus package and the pain ahead was being masked by the belief "a sound system" was still a safe one. 

What we all unfortunately have to get used to now is horrible economic numbers followed by horrible earnings reports.  Not a month.  Not a quarter.  The visibility is horrible, the holidays will stink, more job cuts are coming after the holidays, earnings are looking bad, and you know the rest.  You will see this outlined below, but it seems that for the time being our best bullish hopes may only come in the form of bear market rallies.

Goldman Sachs economist Jan Hatzius recently issued an updated forecast for a deeper recession,
with GDP declining to -3.5% in Q4 and- 2% in Q1-2009. He also predictedthat unemployment will reach 8.5% by the end of 2009, rather than an 8%level previously forecast.  This was even before last week’s >500K in jobless claims.

Richard Haas, President of the Council On Foreign Relations,said less than two weeks ago that it is highly likely that the U.S. will face several quartersof negative growth to be followed by several years of low growth.Forget a V-recovery or even a U-recovery.  He noted that the immediatefuture looks like an L-economy, where you see a sharp contractionfollowed by not much in the way of a quick rebound.  Just last week the >u> dipped into official recession in the U.S., and this morning Japan. 

Nielsen has reported that more than half of U.S. consumers believe that the current economic state will last for morethan a year.  Some 86% of U.S. consumers believe the country iscurrently in a recession and some 54% believe the recession will lastmore than a year.  The report also showed that only about 18% believethe recession will be over within a year.

Frankly, the Nielsen report is just more of the same, but with moreforecasts of additional pain. The Conference Board’s index has nowfallen for 15 consecutive months, with declines in all eightcomponents.  The drop seen in temporary help and part-time workers isparticularly troubling as it signals a complete unwillingness to pay upto accommodate more work and signals poor conditions ahead.  If (andwhen) unemployment crosses 8.0%, that will beat the peak of 7.8% seenat the height of the 1990 levels.  Just last week, we commented thatthose who were braced for 7% unemployment just a while ago, are nowlikely to be bracing for 8%.

China is out whether a stimulus package comes or not.  Over theweekend, the governor of China’s central bank, thePeople’s Bank of China, put 2009 growth for GDP in the 8% to 9% range.The Chinese have an 8% hurdle for the "growth phase" but that numbermight even be sugar-coated compared with reality.  Ships are unable tooffload in some cases because the supplies can’t be placed anywhere andare not needed.  Exports to the U.S. are slowing.  We have even noted that China looks like its nation is going back to candles and rice farming.

The International Herald Tribune spoke with one anonymous monetaryofficial at the World Economic Forum in Dubai saying, "There is a realpossibility of a real, deep, international depression… the worst in100 years."  To further this point, John Thain of Merrill Lynch was quoted recently as saying that the economy was resembling 1929.  The worst Empire Manufacturing number on record at -25.43 for November from -24.62 in October was reported this morning.

We noted how this last month’s retail sales figures were so badthat it doesn’t even look like there is much window shopping.  Here isthe bad news: those very negative year-over-year comparisons with manyshowing double-digit declines are just starting.  Many consumers wereliving in denial up until this last summer and were still using creditand betting they wouldn’t be losing their jobs.  The numbers inlate-2007 and early-2008 were holding up much better than they shouldhave, and that in turn is going to make all of the new monthly numberslook even worse.

In normal times, equities begin to factor in major economic changes oneto two quarters out and many stocks and many sectors see their sharesbottom out even while the bad news is still coming on strong.  Butstocks are still reacting to bad news as though it was not known.There was a brief period where "less bad was good" but that ended lastWednesday and traders went back to selling the bad headlines.  Best Buy dropped on its warning, like that wasn’t easy to see coming.  Toll Brothers fell on its prediction of no profit in 2009 (and a pleafor government assistance), like that wasn’t easy to assume.  Intel rallied on its earnings warning, but that was corrected within a day as the sellers took back control.

A recent report from Barclays took down tech stocks because analysts noticed weak demand and low prices, and this has been echoed by many firms over the last 8 trading days.  We published a detailed report before many of these other reports came out pointing out how low-cost computers at $500 and underis now $400 and under, and this makes selling PC’s as profitable asselling toasters.

OK, so we rant on and on about how poor the economic numbers are and how they are only getting worse. So what about this notion of bear market rallies being the only real upside hope for now? 

The problem for equity investors is that many of these battered stocks and sectors are only cheap becauseof how much they have sold off from their 52-week or all-time highs.  The forward P/E’s are currently about as usefulas gold to a dead man, as the "E" part of the P/E has not been takendown enough by analysts on Wall Street.  We will publishing a piece soon showing which DJIA or major S&P components have the most downside toearnings estimates for 2009, and you can count on this: it won’t bepretty.  But much of this should be known. 

Another problem that has gone on for far too long now is that theefficient market theory does not work.  Traders can’t price inevents because the sell-offs that have been seen only beget moreselling.  The redemptions seen from the mutual funds and hedge funds performing poorly have created an environment where redemptions are coming into play at the funds which have actually been doingrelatively well. 

Investors generally want to find the sweet spot and be in ahead of the major move.  But everything wehave shown here is indicative of the economy being in a "sour spot." The last rally was a total sucker punch.  The week before the election was a monster rally where the DJIA went from 8,100 to over 9,600.  But now, we have given all of this back.  Last week the market dipped under 8,000, and despite a rally back to almost 9,000 we are back under 8,300 late this morning.

As things continue to get worse on the earnings and economic front, about all you can hope for is thattangible book values (not stated book values) hold up.  Those who are not reliant upon major financing or debt issuance will also be a target.  Those companies which can show that earnings and cash flow will hold up rather than losses will then be the sub-set of companies to look for.  But even then, the sweet spot and the efficient market generally applies to one or two quarters out.  So when traders go to make major rallies in these stocks, guess what happens when in another one or two quarters out that the coimpanies are still posting poor numbers and are still offering poor forecasts.  Yep, the realization of a bear market rally. The market cannot hide outin P&G, McDonald’s, or Wal-Mart Stores as their go-to stocksforever.  So what will bring people back into the stock market even if thingshave to get worse before they get better? 

What will bring investors back to the market in droves iswhen you start to see "a compression in the rate of change."   Whenthings are still getting worse and the market can’t see it getting evenless bad, then it is impossible for investors to have any confidencethat they are picking the right time to really start putting a toe inthe water.  Until the smart money feels that there is a reasonablechance that "less-bad news" is around the quarter, how can theyconvince their clients to not withdraw funds?

The rates of home sales have started to look "less bad" but that includes short sales and foreclosure or near-foreclosuresales.  That version of "less-bad" does nothing for theeconomics of what m,exists and doesn’t do anything for manufacturing or even much in the way of servicing.  Car sales can’t plummet foreverbecause cars eventually have to be replaced or become more expensive toservice than the cost of a new or "less-used" car.  Now, politicians are fighting over whether or not they will help the auto sector.  But neither will likely helpthe U.S. auto manufacturing sector in time. Guess what happens if a million more jobs get lost in Ohio, Michigan, and other auto-dependent states comes into play? 

There is still a wide belief that the unemployment, GDP, businessspending, and consumer spending are going to get worse.  That is expected to last longer than a quarter, and we have shown how manybelieve we have a year of that ahead of us.  If corporate earnings stay positive, companies will not have to show growth.  If the major companies aren’tposting losses and if the tangible book values hold up, then investorsare going to start nibbling.  That is when the "E" in the "P/E" analysis will start to be evident. Slightly before then is when the notion that a "bear market rally" may actually become the real feasible rally that is not a head fake for most traders and investors.

Our last parting message is this: Every time the public (smart moneyincluded) believes that the good times will never end, the good timesend rather rapidly.  And when the public believes that caution and painwill last forever, let’s just say that the history books have alwaysproved that to not be the case.

We are in for more pain on the economic and earnings reports and so far every single attempt where buyershave tried to be heroes have been met by a barber appointment at the guillotine.  That will not last forever, but….  Even if a bottoming out in the stocks does end up being the case soon, it seems that all the evidence for now points to a best case scenario is a scenario of bear market rallies.

Jon C. Ogg
November 17, 2008