Are we close to the bottom?

Well, some people seem to think so, and we think that we’re at least due for a little bear-market rally. It would be the other side of the coin of our oil market prediction, oil prices stabilizing, markets stabilizing, or is it?

Why we would be close to the bottom:

  • The market is really oversold
  • The S&P is also now in bear-market territory, being the last index to sink more than 20%
  • Historically, when the S&P sinks more than 20% some fast, V-shaped reaction is imminent, argues Steven Goldberg. From 1956 to 2001, the S&P experienced nine bear markets. On average, by the time the S&P entered bear territory, most of the decline was behind us. Yet, soon after the onset of a bear market, the market generally has risen.
  • James Stack, president of InvesTech Research, says it’s because bear markets tend to be “V”-shaped in their final stages. That is, share prices tend to decline dramatically and quickly as investors capitulate, then rebound just as quickly.

However, before you start to rejoice, consider that it doesn’t always go this way:

  • Twice in the past half-century, the market has experienced an extraordinary bear market. In the 1973–74 downturn, the S&P lost 43%, and in the 2000–2002 bear market, it plunged 47%

So, the question forces itself, are we in the garden variety bear market or more like the super bears of 73-4 and 2000-02? Here is what we think.

  • Goldberg argues that we’re not in the super bear markets like those two periods, as shares weren’t nearly as overvalued to start off with (compared to those periods).
  • Oil prices do indeed play an important role in today’s bear market, and if they, as we think, will not rise a whole lot more that would be a positive, as is the fact that the markets are really oversold
  • However, we think that house prices have further to fall, putting more people in financial distress, which will create more problems in the financial institutions, some more of them might very well experience the kind of problems that Bear Stearns and the Fannies have experienced.

Basically, we think the key to the market is not oil, but housing. And we’re really not ready to call the bottom there. People have done that a couple of months ago, and they got heavily burned.

So, with Bill Clinton, we could say, it’s the housing market, stupid! And having said that, we can only hope things will not develop the way they did in Japan in the 1990s. Housing, land, and stockprices reached truly bizarre heights there at the end of the 1980s (the Nikkei is still less than half it’s top).

A decade of asset price deflation (and a little later also general price deflation) and an extremely large bank bailout were the results. If we compare the situations, there are some things in favour for the US now:

  • Policy reaction has been much more swift, one of the major problems in Japan was the slow recognition, and even slower action policy makers took
  • US Banks are swift to write down bad debts, although we’re pretty sure there is a whole lot more necessary, but we also remember Japanese bank shoveling the problems under the carpet for a long while.

On the other hand, unlike the US today, Japan’s fiscal position was very healthy to start-off with (not at the end of the period though, which only goes to show that those bail-outs will cost a lot of money).

The question is, will it be a V shaped recovery, a U shaped, or an L shaped, like in Japan in the 1990s? The jury is still out. We don’t think the Japanese scenario is all that likely, but we cannot exclude it completely either.