04/15/09   Was 1938 Really All That Great?

Editor’s Corner

Was 1938 Really All That Great?

Ron Rowland

The short-term action in equity markets has flattened after several weeks of furious gains.  The jury is still out on whether the next move will be up or down.  Our guess is the latter.  The nearly +23% rally in the Dow since March 9th is impressive but hardly unprecedented, even within an extended bear market.  There were six such rallies between the October 1929 Crash and the Dow’s ultimate bottom in mid-1932.  This is not to say that history will repeat itself; the point is that even a 23% gain does not necessarily mark the end of a bear market. 

Speaking of the 1930s, we’ve noticed lately that many pundits are comparing 2009 to 1938.  There are some similar patterns, but 1938 was no bed of roses.  As of early March, the Dow was down -48% from August 1937, yet still managed three separate rallies of 20% or more later that year.  However, another bear market got underway before the year completed.  The pundits usually leave out the other facts about 1938;  there were three more bear markets over the next four years that took the Dow back to 1934 levels, the high of 1938 was not seen again for seven more years, and the world was also about to be plunged into the greatest war in history.  Not exactly something to get excited about.
Conspiracy-minded bloggers are atwitter this week about the shrewd decision by Goldman Sachs (GS) to sell stock and use the proceeds to repay the Treasury for last year’s TARP capital infusion – an action which will, not coincidentally, free Goldman from executive compensation restrictions.  The apparent good tidings from Goldman place more pressure on the other large banks that will soon report their “stress test” results.  The government is terrified of bank runs if one or more of the 19 largest banks appears to be substantially weaker than its peers, and it is desperately trying to manage market perceptions.  Look for more fireworks from the financial sector in the near future. 
The slightly positive economic data that sparked recent market gains is now being replaced with more sobering reports.  The Consumer Price Index dropped 0.1% in March, bringing the year-over-year change to -0.4% – the first annual decline in CPI since 1955.  Industrial production is still extremely weak, collapsing at a 20% annual rate during the first quarter; capacity utilization dropped to 69.3% in March.  Deflationary forces are obviously still in control for now, though we suspect the return of inflation is a question of when, not if.  The ten-year Treasury yield fell to its lowest point in almost two weeks today and a new downtrend may be forming.  A trading range between 2.25% and 3% has held since mid-January. 
Technology still holds the momentum lead, but the sector was hit with some bad news this week when Intel (INTC) beat earnings expectations but declined to provide any forward-looking revenue guidance.  Apparently they have no idea what to expect for the rest of 2009.  Consumer Discretionary remains in second place but also came under assault with an unexpected decline in retail sales and a massive plunge in Burger King (BKC) shares.  Consumers appear intent on cutting back spending even at “discount” eateries.  This suggests that the defensive sectors of Utilities, Health Care and Consumer Staples, which now hold the bottom three spots in our rankings, may not stay there for long.  The pattern where we see beaten-down sectors rising to the top and defensive sectors sinking to the bottom is indicative of bargain-seeking and a greater risk appetite by investors. The sustainability of such behavior is suspect.
Volatility remains very high in every corner of the stock market.  All our Style categories flipped from red to green in the last two weeks; they can flip back just as quickly.  Growth is still favored over Value, and the Small Cap categories are gaining momentum quickly – another sign of a growing desire by investors to take on added risk.
Our Global rankings show a preference for emerging markets over developed ones.  Analysts are attributing this to the fact that most emerging market countries had neither over-leveraged financial institutions nor spend-happy consumers.  The export-oriented sectors of their economies will likely continue to feel the pinch of global recession while internal growth and consumption could be bright spots. 




The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

“Some people without brains do an awful lot of talking.”

Taken from the Wizard of Oz (1939)


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