Election Over – Back to Reality
The stock market greeted the news of Barack Obama’s ascent to the presidency with a Bronx cheer. Not that any insult was intended; traders simply have other things on their minds right now. The economy is still weak and appears to be getting weaker. The latest bad news came from ADP Employer Services which revealed companies eliminated 157,000 jobs in October, the most since November 2002. Next week brings more official numbers from the Labor Department which are expected to be equally grim. Virtually every indicator – corporate earnings, wages, retail sales, consumer confidence, manufacturing activity, real estate prices, and more – is now warning of severe recession, and even President Obama seems unlikely to stop it.
Investors celebrated briefly early this week as the calendar flipped to November. Any way you look at it, October was a dismal month. Thanks to a rally in the last week, the monthly numbers disguise the extent of the pain. The S&P 500, for instance, posted a -16.9% loss for the full month but at one point was down as much as -27.2%. The iShares Emerging Markets ETF (EEM) had an even bigger swing: its intra-month maximum drawdown was -43.5%, but EEM ended October with a loss of only -25.6%. Looking at these numbers, it’s not hard to understand the panic felt by many investors. Bankers with leveraged portfolios heroically resisted the urge to defenestrate themselves – but do not be dismayed; they will have other opportunities.
As we have said more than once, the only real solution to the crisis is time. Asset values need to adjust downward, and balance sheets need to be rebuilt. It will be a slow, painful process. The only way to avoid it is to not allow the bubble to expand so much in the first place, and it’s too late for that now. We do not rule out short-term rallies in the next few months, but they will be very difficult to trade successfully. The major benchmarks and key sectors are likely to stay within a trading range for now, bounded roughly by the 10/10 intraday lows and the 10/14 intraday highs. The best strategy will likely be to adopt a defensive allocation and stick with it until we see some resolution in the underlying problems.
Long-term Treasury yields pulled back this week after rising sharply in late October. With the government issuing short-term debt at an unprecedented rate to pay for the various bailout programs, investors seem to be rethinking the relative value of long-term Treasury securities. In the corporate world, the credit crunch remains in effect despite a sharp drop in LIBOR rates. Election Day brought good news for municipal bond investors as jurisdictions from coast to coast gained voter approval to borrow more money. “From whom?” is going to be an interesting question, given how many bond investors were burned this year.
The defensive trio of Consumer Staples, Health Care and Utilities still tops our relative strength rankings. Because these sectors fell the least as the market plunged, they can also be expected to gain the least from any short-term rallies, and that is indeed what we are seeing this week. It is the worst-performing sectors – mainly Energy and Materials – that are bouncing the highest right now. It is far from clear they will continue to do so.
Our Style rankings are holding mostly steady, with Mega Cap still on top but a surprise intrusion by Small Value into the top three. This appears to be less a fundamental change than a consequence of extreme volatility that can change the complexion of the rankings significantly on a short-term basis. We suspect Small Value will fall back again in the near future.
Japanese stocks are near a 26-year low – a feat unmatched by any other developed economy, as far as we can tell. Yet once converted into dollars, Japan is still the strongest (or, more accurately, the least-weak) global stock market. Emerging markets remain in the basement. The good news is that downside momentum appears to be slowing, with all global markets improving their scores considerably this week. Losing less is the first step toward posting actual gains.
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.
“The worse a situation becomes the less it takes to turn it around, the bigger the upside.”
George Soros (b.1930) Investor, Political Activist
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