Friday, October 31, 2008

Does the market bottom in 1Q/2Q 2009?

From Humble Student of the Markets:
Did anyone sit out October?

I wrote in early October that Mebane Faber had done a study indicating that equities could see positive returns in November and December because of the horrible month that stocks saw in September. Faber followed up with a further study entitled What happens after two bad months that point to median gains of 7% for the rest of the year if history were to be any guide. VIX and more came to a similar conclusion on market direction by comparing the current period in the US to Japan:
Japan's "lost decade" does bear some resemblance to the problems in the U.S. Looking at the historical record with a global perspective, it is tempting to conclude that the current situation ripe for another volatility bounce of at least two months.

Waiting for the retest of the lows
Without a doubt, last week’s market was a bottom fishers’ paradise. In addition to running my recent screen of beaten up financials, I ran other deep value screens and found all sorts of companies that were worth more dead than alive. There were 14 stocks trading below net cash (cash – total debt) that were profitable and therefore in at low risk of bankruptcy. There were also 42 stocks trading below net-net working capital (current assets – all liabilities) and were profitable. These are all indications of extreme cheapness that bottom-up value investors are fond of.

However, my sources tell me that many hedge funds have moved to cash and called it quits for the rest of the year (SAC Capital is just one well-known example). Any rally that we may see in the stock market for November and December cannot be regarded as enduring until it can be confirmed in January when hedge funds return to the market.

What bothered me was that a lot of individual investors have been too eager to jump on this rally. I wrote that sentiment was too bullish for this to be a durable bottom. However, sentiment models are not great at timing markets in the very short term....MUCH MORE