Monday, March 2, 2009

A quick note on the stock market

This is a very important chart, which is constructed and hosted by and occasionally mentioned by Calculated Risk. It is one of the many factors that always gave me great confidence that stocks would continue to fall (even in the face of the enormous sucker's rally we had late last year). This chart showed how the current market had yet to fall lower than the tech crash and the 72' crash even though this economy is by far worse than both of those. Today, with this updated version, we finally see that the current market has dropped below '72 and '99.

Note how many sucker's rallies can crop up in a downward market, as people continually make the mistake of thinking that a stock is cheaper because it has fallen 40%. Just because a stock's price has fallen 40% does not mean it is any cheaper than it was before! If the economic conditions have deterioriated enough, and if profits have fallen enough, you could still be paying too much. With operating leverage, it doesn't take a very big drop in sales to yield horrendous results for the bottom line.


Konrad said...

The chart shows that the market has declined more than all other major declines save for the great depression (% wise). Now if you are making some comparisons of valuation using a metric such as P/E or something vs. the couple other major declines then that data is not shown as part of the graph.

Problems with graphs such as these, as you are probably well aware is that you can't determine when the market turns around.

If you're using the graph to indicate that on average, vs. the other major bear markets, the bear market will continue for another 6-12 months, and if this rings true, the general direction will be down, then I can see that but I couldn't tell from your post that that was what you were getting at.

You could also argue from the graph that if we are now at the inflection point of a bounce, it will bounce up 5-10% from current values. At best a good trade if the call is right. And assuming that the direction will revert downwards.

At some point the price of stocks can't go any lower. Example Citigroup and AIG are pretty low, dollar wise. And some stocks could go lower. GE could go to 1, Bank of America can go to 1, etc. I would think that these would be very extreme circumstances but the next 6 months (?) or so will probably tell. So for the S&P to drop another 100 points or so, a lot of stock that have been doing ok would have to do poorly.

I hear that some technical analysts are talking about 740 week close on the S&P. If the S&P doesn't close above 740 at the end of the week, it has broken through support levels and is therefore very bearish. The S&P is currently, well below 740. Currently at 696. Apparently, closing the week below 740 has more meaning that a close during the week.

Rick said...

Great comments Konrad, thanks for writing in.

I didn't really mean anything by my chart posting other than to illustrate that we're now in the second-worst market we've had save for the Great Depression.

I do take issue with your comment that at some point stocks can't go any lower. Mathematically speaking, C and BAC can fall 5% per day every day from now until eternity. This isn't meant to be a sarcastic quip...if you were new to investing and invested in Citigroup today, losing 5% per day from your starting point hurts every bit as much as it did for the folks who owned at $60 per share. The fact that it has fallen 95% to get to here is irrelevant.

It's also important not to put too much emphasis on the price of an individual share of stock. The fact that a share of stock has fallen to $1 is meaningless. Keep in mind that in Citigroup's case the government came in and diluted Citi's shares with it's bailout to the point where you'd need to roughly multiple your price by 4 to compare it to a week ago.

These stocks have all kinds of room to continue to fall. Bank of America has fallen all the way to $3 per share, but more important, consider the market cap. BAC is still selling for an astonishing $16 billion! There is $16 billion left to be lost in this company.

As for the technical analysis comments, I really don't pay much attention to that area so there isn't much I can say. I don't really believe in support levels for an index because it is an amalgamation of 500 different companies. They are trading at all different levels from the last time the index was this low, and at all different volumes. It isn't one company where someone out there is trying to hold it up for support. It just happens to work out to the number we see that day. To suggest anything more is trying to see patterns where they do not exist, in my opinion.