Whiplashing of Wall Street – where to now?
The MSCI World Index shed 11.0% between its high on July 19, 2007 and August 16, with the S&P 500 Index declining in similar fashion by 9.4%. At that stage high-yield debt markets had completely stalled, investment funds had blocked redemptions and the VIX had reached a high not seen since October 1987.
However, rescue was at hand as the world’s central banks – the Fed, the ECB, the Bank of Canada, the Bank of Japan and others – let it be known that they were dumping money into the system. The Fed went one step further and announced a discount rate cut of 0.5% on August 17.
Calmed by the central banks’ actions, stock markets around the globe staged a rebound. By Friday last week (September 7) the MSCI World Index and the S&P 500 Index were respectively -6.8% and -6.4% below their July highs.
Although investors are relieved by the recovery, they are wondering what to do next. Before debating this critical issue, let’s focus for a moment on the graph of the broadest US stock index, namely the Wilshire 5 000 Index.
The most notable observation is the fact that Friday’s sell-off resulted in the index again closing below its 200-day moving average, although this primary trend indicator was still rising. But perhaps more important is the volume chart showing that the rally since mid-August has been characterized by rather poor volume. This lack of breadth is worrying and casts doubt on the sustainability of the bounce.
This viewpoint is augmented by Dr John Hussman’s remark in his commentary of September 3: “… the market climate for stocks remained characterized by unfavorable valuations and unfavorable market action. The market has now cleared the oversold condition that we observed several weeks ago, yet breadth and trading volume have not evidenced the strength and persistence that we typically associate with more sustained recoveries from oversold conditions. That’s not to say that we can’t observe further market strength, but at present we have no evidence either from valuations or from market action to reliably speculate on such strength.”
At this juncture it is perhaps sensible to reflect on the fundamental picture. A very apt assessment comes from friend Kevin Wilson’s Market Perspectives. Kevin said: “I don’t believe in hedged answers, so that forces me to make the call in a clear fashion, at least as a mental exercise. I think that the chances are 65% in favor of recession, for the following reasons:
This brings us to the question of whether the market correction will transform itself into a full-fledged bear market. “I think the answer is scary,” said Kevin. “I would guess the chances of descending into a bear market are 80% within three months. Here’s why:
Against this background should investors increase or curtail risk in their investment portfolios? As I see it, factoring in a prudent analysis of the possible unfolding of events, it might be sensible to adopt a more defensive approach to risk and err on the side of caution. As a parting comment, somebody famous pointed out that “wishful thinking” (especially of the CNBC variety) is an oxymoron. It’s wishful, but it’s not thinking.
Hat tip: Rob Fraim
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