Economic woes torpedo stock markets

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Yesterday was another ugly day for stocks, with bourses around the globe falling victim to strong selling pressure. Fueling the sell-off were concerns that the economic recession could not only be deeper and longer than previously feared, but also fall into a corrosive deflationary phase.

The MSCI World Index and the MSCI Emerging Markets Index fell by 4.6% and 2.2% respectively, tallying declines of 51.2% and 63.4% since the peaks of these indices in October 2007. Only the Chinese Shanghai Composite Index (+6.0%) and the Russian Trading System Index (+0.7%) bucked yesterday’s declines.

Click here or on the thumbnail below for a (very red) market map, obtained from Finviz, providing a quick overview of the performance of global stock markets (as reflected by the movements of ADR stocks).

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As far as the US markets are concerned, the Dow Jones Industrial Index (-5.1%) plunged below the roundophobia 8,000 level, resulting in all the major indices now trading below the recent lows of October 10 and 27. This brings the lows of 2003 (Dow 7,524; S&P 500 801) and 2002 (Dow 7,286; S&P 500 777) into sight. A breach of these levels – frightfully close to the current levels of the Dow (7,997) and S&P 500 (807) – will wipe out the entire five-year bull market from 2002 to 2007.

Interestingly, only 2.4% of the 500 S&P 500 stocks now trade above their 200-day moving averages. This line is often used as a crude indicator of the primary trend of a market or individual stocks. The graph undeniably shows an extremely oversold situation, but bear markets have been known to stay oversold much longer than usual.

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One can argue long and hard about valuation levels and earnings forecasts, but the extent to which stocks become undervalued in the grip of this bear is squarely in the hand of the severity of the economic meltdown. This is clearly shown by the relationship between the Dow Jones World Index and the Baltic Dry Index – an assessment of the price of moving the major raw materials, including coal, iron ore and grain, by sea and generally an excellent barometer of economic activity.

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The worrisome prospects for economic and earnings growth, together with the threat of deflation, are spooking the financial markets. The extreme level of risk aversion is illustrated by the US three-month Treasury Bill rate falling to a minuscule 0.065% – a clear sign of distress and fear – and the yields on long-dated government bonds falling significantly in most parts of the world.

Here is what Richard Russell (Dow Theory Letters) – one of the few market commentators with first-hand experience of the Great Depression – has to say: “The market is warning of a coming depression. Next year there’ll be a huge problem of unemployment, job openings will have disappeared, and every business will be going over its personal thinking in terms of who the business can do without.

“The sentiment in the country will be dark grey to jet black. Fortunes will have been wiped out. Thousands of savings plans and 401Ks will have been shattered. Americans who have never experienced true hard times will be living hard times. Confusion and fear will be rampant. How do I know all this? I’ve been here before, I know the signs.”

Oversold conditions have so far not produced more than a temporary reprieve, and nobody knows how far down this bear market will fall. Until we see more signs of base formations being developed, one should tread very cautiously. And remember the old Boy Scout adage: “Be prepared”.

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6 comments to Economic woes torpedo stock markets

  • So, do you think Russell is recommending that we all go 100% to cash, even at this late date? If we haven’t sold yet, does Russell recommend to sell now, or as Donald Coxe advises, it’s too late to sell and hold and begin to reposition for the inevitable although who knows when rally?

  • Mark: This is from Richard’s newsletter of Tuesday: “Here’s what I’ve been thinking. In my gut, and based on my numerous studies, I believe the Dow is going lower. We are not yet at or near a major bottom. That eliminates buying stocks for me. Since the facts that I operate on have changed, I’ve changed. I have eliminated about all my common stocks, even those I recently recommended.

    “Instead, I have been looking at high grade municipal bonds, AAA-rated and paying 5.1% free of federal and state taxes. If I receive 5.1% a year in income from these bonds, in five years I will have collected better than 25% free of taxes. I don’t believe buying a good selection of stocks in the current area will bring in an after-tax yield of 25% in five years.”

  • This is market is truly a mess with little to nothing to put money into. You do a very good job of outlining the issues facing the markets this week. Hopefully a change in administration will create a bounce in the markets. That is the only positive that I can see at this time.

  • Frank Wordick

    Sedacca must be saying “I told you so!” When markets go down hard — and this one dropped around 6 sigmas below the 200-day moving average — they are not invariably followed by strong rallies. I think this last one barely achieved a 19% one. Bear markets can and do go down and stay down. The other thing that has now been proven is that hoping and praying are not good ways to deal with a financial crisis. You have to get off your dead rear end and do something. And when you do, do it right! One other comment. Sedacca does not like municipal bonds, because the interest they pay is not commensurate with the risk they offer. You may recall that the insurers that insure municipalities have lost their AAA ratings because they got in bed with subprime mortgages. Consequently, municipals have also lost their elevated ratings. Worse, during recessions municipalities experience significantly reduced cash flows, meaning they are further impaired. This may be ameliorated by Federal handouts, but I don’t think this is something to depend on. Sedacca, you may recall, recommends Ginnie Mae pools at between 6 and 7%. He claims they pose no risk.

  • Frank Wordick

    Back again! I forgot to thank Scout Master Prieur for his good advice! Also, I would like to make an additional comment. The downward breech of the 8000 support level is not really that much of a disaster, tho obviously it was not welcomed by many. The support that this level provides is in the scaling in which the market price is displayed. It is not necessarily recognized in the structure of the market. What may well be a catastrophy is a significant penetration of the 7000 level. This level turned the 2000-2002 downdip around.

  • [...] see a return to lower volatility levels and a return of confidence. (Also read my recent posts “Economic woes torpedo stock markets” and “Panic-crash sentiment causes extreme [...]

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