Ad Hoc Commentary: Looking for a Bottom
(August 9, 2011)
Dear Subscribers and Readers,
As I am typing this, S&P futures are down about 14 points, suggesting a >125-point decline in the Dow Industrials. Tomorrow brings the conclusion of the latest FOMC meeting. I expect the FOMC statement to be revised to indicate that the Fed will keep its current balance sheet holdings for an “extended period”—thus ensuring that no Treasuries or Agency securities on its balance sheet will be sold anytime soon. From a psychological standpoint, this will have the effect of a small easing. Given the market decline over the last several weeks, I do not expect the Fed to raise rates until late 2013, or even early 2014.
I did not expect the DJIA to decline by as much as 634.76 points (5.55%), and the Dow Transports 330.09 points (7.03%) earlier today. For the first time since the Great Depression, the Fed and the U.S. government effectively have their hands tied in propping up the market—the former by political constraints and the latter by fiscal constraints (although the Treasury Secretary could in theory utilize the $100 billion Exchange Stabilization Fund to stabilize the stock/credit markets without consulting Congress). The baton has instead been passed to the European Central Bank. Their purchases of Italian and Spanish sovereign debt earlier today has removed any concerns of solvency for these two countries—at least for now. Going forward, the ECB would need to wrestle more budgetary concessions—and keep on buying their debts as well. As we mentioned in yesterday's commentary, we believe such purchases would need to amount to at least 250 billion Euros.
The markets are now highly oversold in the short-run. For example, the daily equity put/call ratio hit 1.08—its highest level since mid-June. The 10-day MA of the equity put/call ratio hit 0.80—its most oversold level since late June. The percentage of stocks on the NYSE above their 200-EMAs declined to 6.42%(!)—its lowest level since March 2009 (at the bottom of the last bear market). Meanwhile, the VIX spiked 50% today to 48.00, which is equivalent to its highest level last summer (the S&P 500 bottomed at 1,022.58 on July 2, 2010). Meanwhile, the dividend yield of the S&P 500 hit 2.3%. This is its highest level since July 2009; and more important is on par with the 10-year Treasury yield. Note that the last time this occurred was April 2009 (a month after the last bear market ended).
Subscribers should note that there is a great deal of uncertainty since we are now adjusting to a new financial regime. As such, it is not surprising to see the large declines in equities today. Given the festering European Sovereign Debt Crisis—as well as doubts over the ECB's ability to respond—I would not be surprised if the markets decline further over the next several weeks. However, the technical oversold conditions are coming into place for at least a temporary bottom in equities, especially given unprecedented cash levels and cash flows at the world's biggest companies.
We have been completely neutral in our DJIA Timing System since December 15, 2010, and we are itching to get back into the stock market (likely with an initial 50% long position) at the earliest sign of a sustainable bottom. We may even go in for a relatively quick trade—should the market decline in a major way again tomorrow (Tuesday), we will definitely reevaluate and let you know our thoughts.
Please let us know if you have any comments or questions, as always!
Henry To, CFA, CAIA