We are not sure who coined the above phrase. Some say it was Baron Rothschild, the scion of the Rothschild banking family. What it means is that when fear is at its highest, one must toss aside the bearish feeling and turn bullish. Of course the $64 million question is, "Are we there yet?" As the market sank this past week one could be forgiven if even the most optimistic amongst us turned out to be wrong as well.
The original quote is believed to be "Buy when there is blood in the streets, even if the blood is your own". Well, we have suffered some bleeding. We guess the question now is, have we bled enough or is there more to come?
In last week's Scoop we premised that the financial panic of 2008 was more akin to the financial panics of 1907, 1937-38 and 1973-74 than the seemingly endless liquidation of 1929-32. We also premised that the equivalent of that famous 1930-32 collapse in the Dow Jones Industrials (DJI) was the NASDAQ in 2000-02. The DJI was the cutting edge index in its time, and it fell 89 per cent. The NASDAQ fell 78 per cent.
If we are in the throes of a monumental collapse á la 1929-32, we have a long way to go before we see the bottom. That collapse was a series of endless liquidations. The bottom did not come in until after the swearing-in of a new president - Franklin Roosevelt, in March 1933. We don't have quite as long to wait for the next new president; only until January 20, 2009.
We held off showing that horrible chart of 1929-32 but it is a lesson. From the highs of September 1929 there were seven declines and six rebounds a 13-wave decline. The declines varied from 30 per cent to 50 per cent. The first decline, which included the 1929 stock market crash, was the worst: 50 per cent. The six rebounds varied from 19 per cent to 52 per cent. If the first decline was the steepest, the first rebound was also the best one.
The 1937-38 financial panic was quite different. In total the market lost 50 per cent. It fell in five wave decline. The first collapse was only 17 per cent. The ensuing rebound was also 17 per cent. The second collapse was for 41 per cent, with the final plunge coming in two parts, with a short-term rebound and then the final drop. What followed was a three-month choppy rebound that added about 21 per cent. The final wave collapse was for 28 per cent.
The 1973-74 financial panic was different again. The market lost a total of 47 per cent. Again we see what appears five wave decline. The first drop was a very choppy one but ultimately lost 21 per cent. The swift rebound regained 18 per cent. The next drop was short and swift as well, losing 22 per cent. What followed was a choppy rebound that lasted six months but at the top had regained only 15 per cent. The final drop also lasted six months and made the double bottom low in October and December 1974, for a loss of 37 per cent.
Flash forward to today's market, where we made our final top in October 2007. Our first decline that lasted into January (setting aside the mini-rebound in November and December) lost 19 per cent. The rebound, which tested the lows in March 2008 (and many others made new lows) lasted until May and gained 15 per cent. The second decline was into July 2008, losing 19 per cent again, and the subsequent rebound into August gained 11 per cent. The final collapse into what thus far has been the low in October lost 35 per cent. The final plunges in these three markets were 28, 37 and 35 per cent respectively. In total we lost 46 per cent - very comparable to the two aforementioned panics.
In structure, this decline has thus far also looked more like the two aforementioned panics. The 1907 financial panic declined in three stages and not the five-stage declines of 1937-38, 1973-74 and (assuming we are at the lows) 2007-08. Even in time there are some similarities. The 1937-38 decline lasted 386 days while the 1973-74 decline lasted 698 days - nearly twice as long. For the current decline, October 10, 2008 was Day 365 and the October 27 low was Day 382. The Great Depression of 1929-32 lasted almost three years, or about 1,000 days.
The background news has been relentlessly gloomy, yet it has now been over a month since the markets generally made their lows. The DJI's was on October 10. The S&P 500 did see small new lows this past week on November 13 coinciding with a huge reversal up day. The NASDAQ also made small new lows on November 13 coinciding with a huge reversal up day. The TSX Composite made its low with a double bottom on October 27-28. Despite attempts to take out these lows, we have successfully rebounded each time. Volatility as measured by the VIX Indicator peaked on October 24. While it has eased since then, it has remained high. The collapse has been spectacular and has taken a serious bite out of retirement funds, mutual funds and pension funds.
Yet the market can rebound quite quickly as well. A year after the lows in 1907 the markets had recouped 66 per cent; a year after the lows of 1974 they were up 40 per cent. The market was tougher in 1938 because a year later the world went to war, but still they were up 23 per cent. Naturally it took a while to regain the highs. The highs of 1907 were not surpassed for good until 1915; the highs of 1973 were not surpassed for good until 1983 and those of 1937 were not surpassed for good until 1949-50. We will certainly not be surprised if it took us a decade or more to see the highs of 2007 again. But then markets can sometimes certainly surprise.
The financial panics of 1907, 1937-38 and 1973-74 were the worst market collapses of the past century, with the one exception of 1929-32. Only that market went into endless liquidation. One has to take into account some conditions that existed then that do not exist today. They are as follows:
During 1929-32 the Fed hiked interest rates. This time they are cutting them.
The Smoot-Hawley law of June 1930 raised US tariffs on host of imported goods and set in motion trade wars. We don't believe that will happen this time around and avoiding protectionism was a key note from this weekend's G20 meeting.
The Fed tightened money supply. Rather than providing backup to the banking system, the Fed let it fail. This caused a huge contraction in money supply. This time they are expanding money supply and bailing out the banking system.
Society at that time was primarily rural/agrarian and manufacturing. This time we are an urban society dominated by service jobs in high technology, finance and sales (setting aside the massive number of McJobs).
The common factors were market euphoria, and bubbles created prior to the collapse because of easy credit.
The Great Depression was made worse because social safety nets such as unemployment insurance, social security, Medicare and welfare programs did not exist then.
It wasn't until Roosevelt took office and instituted the New Deal which included massive infrastructure spending that the stock market and the economy began to turn around. In the end it also took a war to raise employment levels back to pre-Depression levels.
Today we are getting nothing but gloomy news. Volatility and negative sentiment have never been worse. But these are the conditions that often give us bottoms. We are not saying we are out of the woods; at some point, lower lows may occur. But we are saying that we may be in the early stages of creating a more substantial bottom that may still have months to play out, with many twists and turns.
Certainly we would be foolish to assume at this stage that we have seen the absolute bottom. One can only determine that in hindsight. This is a bottom, not necessarily the bottom. It may be the latter but we need to work our way through a lot more. Risks continue to abound.
The G20 meetings this weekend accomplished very little. Not that much was expected. In June 1933 a similar global conference also accomplished very little. However, we do note the market after rallying from March 1933 paused in June before taking off again. Like Obama though, Roosevelt did not attend the 1933 meeting as Roosevelt had already decided to turn inward and go it alone for America. Obama does not have that luxury when you are indebted to the rest of the world even if he missed the meeting because officially he is not yet President. But unlike that conference of yesteryears the world is not in the throes of dying imperialism (Britain), dogmatic communism (Russia), rising fascism (Germany) and of course Roosevelt was burdened with collapsing capitalism. Today we have only the latter although there is no doubt that America may be in the throes of dying imperialism even if it has never been called that.
The Federal Reserve is not in the same position to bail out the world the way it used to. It needs the co-operation of all central banks. With a grossly weakened USA there is no one country or countries that can adequately replace the USA. Europe is equally if not worse battered by this crisis, Japan is in no position either and China is to new to the game to run the show. We hardly think of China as a bastion of world capitalism.
The US is bogged down in debt that is rapidly approaching $11 trillion. There is a real risk of $1 trillion deficits. More than 40 per cent of US debt is held by foreigners primarily China, Japan and Saudi Arabia. The US is no position to dictate terms to its creditors. The US has huge unfunded debt of Social Security, Medicare and Medicaid. That problem as well plays itself out over numerous companies whose pension funds are now grossly underfunded and have very little in their arsenal to ever catch up.
The crisis continues. Credit card debt is on the verge of toppling (and along with it probably car loan debt). Losses in these two areas have been rising but any final numbers are unknown.
The housing crisis continues with numerous mortgages due for renewal in 2009. Lenders are charging high interest rates due to both the tightness of credit and fear of not collecting. This just makes the situation worse. While plans are being for upcoming mortgages to try and prevent another huge wave of defaults it does nothing for the thousands that have already been foreclosed and lost their homes.
With retail sales plunging and the upcoming Christmas season promising to be bleak there are probably more large retailers teetering on the brink of bankruptcy.
The major big three automobile companies are all teetering on the brink of bankruptcy with hundreds of thousands of jobs in the balance.
The unemployment rate has not peeked. While the consensus appears to be upwards of 10 per cent at least the rate could go substantially higher.
Inflation could once again rear its ugly head given the huge monetary stimulus being provided by the monetary authorities.
Global business conditions continue to deteriorate and will probably get worse before it gets better.
America's ideological rift is real and could become more pronounced under Obama preventing anything of any substance being accomplished. That would probably exacerbate the current malaise.
America remains embroiled in two wars that have accomplished little at huge cost. Failure to end these wars will soon give back the elation over the election of Obama and continue to add to the cost which is being primarily funded by foreigners.
Despite the recent rise in the value of the US$ it has gone up primarily due to technical reasons as hedge funds and others repatriate foreign assets. A US$ crisis would exacerbate the situation for the US and probably cause interest rates to rise. On the other hand a US$ crisis would be positive for gold.
There is no magic elixir for the cure of the market. While we believe we are at a low it will still take many months of work and no new lows before we can determine whether we have put in our lows. We have often remarked on the similarities between the markets of the 1930's and this decade. We can only hope that continues. We compare the two below and are showing that chart of the 1930's and early 1940's.
|DJI tops September 1929||DJI tops January 2000 although S&P 500 and |
NASDAQ top in March 2000
|Big collapse in July 1932 losing 89%||Big collapse into October 2002 |
NASDAQ losing 78%
|Bottom March 1933 followed by huge rally||Bottom March 2003 followed by huge rally|
|Market pause 1934||Market pause 2004|
|Big rally 1935 to 1937 topped March 1937||Market continued to pause in 2005 but a huge |
rally followed to top October 2007
|Panic of 1937/1938 bottomed in March 1938||Panic of 2007/2008 may have bottomed |
in October/November 2008
|1938/1939 saw a rise in the market and a |
generally sideways market until start of
war September 1939.
|Collapse in 1940 as war is firmly underway||TBD|
|Small rebound into latter part of 1940/1941 |
followed by huge final collapse into 1942 with
small new lows below 1938 lows.
If we continue to follow the earlier decade's road map we should see a feeble recovery in 2009 followed by another collapse in 2010. Another feeble rise could get underway in 2011 and then we plunge to our final lows in 2012. The scary alternative is that a feeble recovery into 2009 is followed by a further collapse to new lows and while we follow the road map the final lows of 2012 are made some 40 to 50 per cent below today's lows. We certainly hope not but it is possible if things do not go well in attempting to restructure the world. But right now the scenario still calls for a rebound into 2009.
There is another market we would like to look at that is also seeing blood in the streets. That is the oil market. The collapse of oil prices, while not completely unexpected, has caught many unprepared because of its steepness and velocity. The collapse also spread to the energy stocks, many of which were not trading at overvalued levels in the first place and which are now even more undervalued.
In looking at the market we have noted that there appears to be a four-year cycle (Merriman - MMA Market Analyst www.mmacycles.com) in oil prices. Merriman has raised the possibility of a 12/13-year cycle as well. Trouble is, oil prices have been trading on a futures exchange only since 1983. Prior to that, prices were controlled by a cartel of oil companies until the Arab oil embargo that initially occurred following the 1967 Arab-Israeli Six-Day War. That embargo lasted only three months. The second and more serious one got underway in October 1973 and was a factor behind the 1973-74 financial panic. It coincided with the 1973 Yom Kippur-Ramadan War.
In 1979 the Iranian crisis broke out with the fall of the Shah and the Iranian Revolution that culminated in the seizing of the American Embassy hostages. Oil prices soared to $40 (equivalent to over $110 today). After the hostage crisis ended oil prices began a slow descent and then crashed in 1985. Our first good low was made then. In total, oil prices fell some 75 per cent but took five years to do so.
The next crash took place following Gulf War I in 1991. Oil prices peaked at $41 in 1990, prior to the start of the war. But it wasn't until 1998 that they made their final bottom, once again losing some 75 per cent from the highs of 1990.
Our chart labels what Merriman believes are examples of a four-year cycle in oil prices. The lows occurred in 1986 (April), 1990 (June), 1993 (December), 1998 (December), 2001 (December) and 2007 (January). While the average is roughly four years, it has ranged from 36 to 61 months. Those actually occurred with the series from 1998 to 2007 and the average worked out to four years.
Merriman has alluded to the possibilities of 12/13-year cycle with the two huge lows made in 1986 and 1998. Both lost roughly 75 per cent from top to bottom but the time between the two was measured in years, not a few months. If it exists then the next one is due between 2009 and 2011.
The collapse that has taken place this year from the highs of $147 has been steep: 62 per cent so far. If the 75 per cent figure holds, then the low could be made as early as sometime next year near $35/$40. If that were to occur it would be a huge buying opportunity for oil and gas stocks.
The reality is that the current malaise in oil is unsustainable. Demand has fallen due to recessionary fears, but the reality is that the world's global production is declining and new sources are difficult to find. We reiterate that the no major discoveries have been made in 30 years. Much of the world's reserves are in the war-torn Middle East; in Canada's oil sands - a huge reserve, but increasingly expensive to extract and extremely polluting; and in difficult areas such as deep beneath the ocean, or in the Arctic regions. Finally the current price of oil is too low below the cost of new sources of production. With OPEC cutting back and the unlikelihood of new sources coming on stream at these prices the longer term outlook for oil remains very bullish.
While we may be temporarily at a low in oil prices and we are due for a rebound, resistance will now be seen in the $90/$110 range but due to weak demand it may be difficult regaining much above $80. After an attempt to go to higher prices we could easily see another decline and possible targets down to $35/$40 for our final bottom of this much larger cycle. Investors should be aware of that possibility.
But in the interim the gloom out there is pervasive. There is blood in the streets and that is the time to buy, not to be shy. But the forming of any significant final bottom could still be several months away.
Note: Chart created using Omega TradeStation. Chart data supplied by Dial Data.