Turning Off the Noise
Nerves are frayed, eyes are glued to the TV for the latest updates and cheers/boos go up for every wiggle – unfortunately it is not the NCAA tournament beginning today, but each bit of news coming from Japan. From live updates showing a release of hydrogen, an apparent explosion to comments from the EU minister of energy yesterday, the markets around the world are focused solely upon the six nuclear reactors and are making long-term investment decisions based upon whether anything happened over the past hour or two. I am the last person to talk about nuclear energy, let alone the economic impact of the rebuilding process and how long it may take, but this does not take away from what investors should be looking at when assessing whether to buy stocks at this point or expect that prices will go lower still.
Taking out all the emotion of the day, let’s take a look at the SP500 chart going back to the September bottom.
S&P 500 September Bottom
If you take a look at a simple retracement zone based upon the ratio of the lows to highs, would put the first resting point around the 1220-1230 level for the SP500. What makes that initial (likely?) stopping point is that region corresponds to the April 2010 peak (not shown) as well as the lows in 2006. Given little overall support around the 50% retracement level, the next stop is likely the 1140-1150 level which corresponds to the summer 2010 highs as well as the January 2010 peaks in the markets.
Unfortunately, emotion is what fuels the markets and although those points may be reached over the coming weeks (or days at the rate we’re going!) the very rapid deterioration of the indices have moved them from being over-bought to now over-sold and ripe for a bounce. Given the levels identified above, that may occur rapidly as was seen in Japan after heavy three days of selling.
The economy should enter the discussion at some point – and here is as good as any. The data indicates (surprised?) that inflation at the producer level is up significantly from the prior month and continues to pressure companies to either raise prices to pass along those increases or eat them in the form of lower margins. So far, the pressures have not materialized at the corporate level as margins remain near all-time highs. Some of the prices have been passed along, but over the past year, producer prices have been rising at better than twice the rate of consumer price increases. Yes, we can debate whether the CPI truly reflects prices paid by the consumer, however judging by the prices that many are paying at the pump and at the grocery store, more of the producer price gains have indeed been passed along to the consumer.
Housing remains mired in a political quagmire, as various proposals have been put forth to force banks to reduce outstanding loan balances for those struggling to pay mortgages, while their neighbor suffering from “payment envy” watches the value of his house also suffer. Unfortunately, housing will be an economic drag for quite some time as inventory has yet to be cleared, whether “shadow inventory” or otherwise. Many have been waiting for improvement in the job market in order to signal a turn/bottom in housing. On that front, we may be seeing better days ahead. Below is a chart of the fiscal year end tax deposits made primarily from withheld income and employment taxes. True to the employment decline, revenue also declined, however has been slowly coming back as has employment. The 2000 recession took four years to recover back to prior peaks and this one will likely take a bit longer, but it is heading in the right direction. It has been argued that much of the gains from 2005 to 2008 were as a result of the gains in housing related industries that are now merely a shell of their former robust size. So as the employment situation improves, over time, I would expect the housing sector to do likewise – slowly over time.
September Total Payroll Tax Collected
Back to the financial markets for a quick wrap-up before heading back to the TV for more basketball! One thing that is very different with this market decline and large declines of the past was the lack of “warnings” – which have occurred prior to many of the major/long-term declines. Unlike 9/11 – an event outside of the economic condition, the market declines were preceded by periods of internal deterioration (net declines above net advancing stocks) or bonds beginning to outperform stocks (as was the case beginning in 2007). The current market environment, up to the earthquake and tsunami, was relatively strong with a rising number of net advancing stocks, stocks had been performing much better than bonds and volume was supportive of the rising markets. As with the financial markets after the market reopened following 9/11 and absorbing the initial decline, stocks rose to close above the levels prior to 9/11 – before weak economic conditions took stocks back down. While the only common thread between 9/11 and the earthquake is that both are non-economic events, I would expect a recovery in the financial markets once the nuclear issues can be solved in the weeks ahead. Afterwards the markets will once again be driven by economic issues and the aftermath of the Japanese rebuilding – right now it is all about nuclear risk.
About Paul J Nolte CFA
Paul J Nolte CFA Archive
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