by
Liz
Ann Sonders, Senior Vice President, Chief
Investment Strategist, Charles
Schwab & Co., Inc.
January 22, 2008
Note from Liz Ann: Talk about a moving
target! I wrote what's below early this morning,
in advance of the Fed's emergency 75-basis-point
interest rate cut. Instead of rewriting the entire
piece, I thought I'd just write this qualifier
first and then give you the opportunity to read
the earlier edition. I think there might still
some interesting historical statistics worth
reading.
The move by the Fed was its first emergency
move since 2001. It lowered the benchmark
overnight lending rate (fed funds rate) and the
discount rate to 3.5% from 4.25% even though the
next meeting isn't scheduled until January
29–30. The Fed's statement noted, "While
strains in short-term funding markets have eased
somewhat, broader financial market conditions have
continued to deteriorate." No one knows for
sure whether this takes a rate cut off the table
for the meeting at the end of the month, but
assuming the financial markets avoid a tailspin,
the Fed is more likely to hold off than cut rates
again. If the markets and/or the economic data
deteriorate between now and then, another rate cut
will be more likely.
The markets are having a somewhat delayed reaction
to what has been grim economic and credit markets
news for some time. This is not shocking nor
should it lead to panic by investors. Days and
weeks like these should reinforce the message we
consistently reinforce, which is to monitor
portfolio risk levels (relative to your own risk
tolerance), heed the need for rebalancing when
exposure gets out of whack, and don't let fear or
greed drive you into short-term market timing,
especially in a reactionary way. One mistake that
tends to be made over and over during waterfall
declines is selling out at the maximum point of
pain, fear and panic. Think back to the crash of
1987 and whether it was best to sell into the
decline. Of course not. We wouldn't necessarily
advocate swallowing fear and buying aggressively
in the hopes of picking a bottom either. Hanging
tight on days like today is typically the best
strategy.
So much for a day off yesterday. I don't
know about many of you, but I was certainly glued
to Bloomberg News and my Bloomberg terminal
yesterday, watching an utter drubbing in the
foreign markets, most of which is carrying into
their trading days today, too. More than half of
the world's biggest stock indexes are now
officially into bear market territory (–20% or
more from a high). Some of the European markets
rebounded as the trading days progressed and even
our futures market showed a few attempts at
rallying off their depths as we headed toward our
market open.
During the past couple of days, the market is
digesting what I wrote about in my latest
articles, "Over the Hills and Far Away …
Growth is Slowing Globally, Too" and
"Looking Through the Valley to
Recovery." The economic slowdown is not
contained within the United States. It's a global
affair and not only is our market coming to grips
with the likelihood we're already in a recession,
foreign markets are newly awakening to the
realities of slower growth.
Today's open for the U.S. markets is set to be the
biggest gap down opening since September 17, 2001,
the day the market reopened after the 9/11
attacks. As noted by Bespoke Investment Group (B.I.G.),
using the S&P 500 exchange-traded fund (SPY)
as a proxy, they looked back at the 10 largest
negative opening gaps since 1994. As you can see
in the table below, the market has traded positive
from the open to close during eight of the
previous nine occurrences for an average return of
2.7%.
| 9/17/01 |
–8.2% |
3.3% |
First day following 9/11 |
| 9/21/01 |
–4.7% |
3.4% |
Bomb scare at London Stock
Exchange |
| 10/28/97 |
–3.2% |
9.3% |
Market declines force early
close prior day |
| 1/13/99 |
–3.1% |
2.5% |
Brazil currency devaluation |
| 4/4/94 |
–2.8% |
1.3% |
Stronger-than-expected jobs
report |
| 5/6/94 |
–2.7% |
1.8% |
Stronger-than-expected jobs
report |
| 10/8/98 |
–2.6% |
2.2% |
Russia/emerging market
crisis |
| 9/17/98 |
–2.6% |
–0.2% |
Russia/emerging market
crisis |
| 4/8/96 |
–2.5% |
0.8% |
Stronger-than-expected jobs
report |
Source: Bespoke Investment
Group (B.I.G.). As of January 22, 2008.
From the looks of this table, historical rewards
have accompanied extremely weak opens. But as you
can also see, most of these historical events were
singular vs. the more protracted set of problems
we currently face.
Of course, we won't know how the market behaves
throughout the day until 4 p.m. ET. If the S&P
500 were to close at expected opening levels
today, according to B.I.G., it would put the index
3.6 standard deviations (SDs) below its 50-day
moving average. Since 1929 there have only been 14
other periods where it closed at similar oversold
levels. As shown in the table below, based on
historical precedent, although a snap-back rally
can be expected, it may be short-lived.
| 10/23/29 |
-3.5 |
-13.8% |
-13.6% |
-20.0% |
-18.7% |
| 5/7/34 |
-3.6 |
-9.8% |
-3.7% |
-9.3% |
-11.2% |
| 7/26/34 |
-4.0 |
-16.2% |
7.8% |
11.8% |
6.8% |
| 5/13/40 |
-5.0 |
-9.8% |
-11.9% |
-19.1% |
-6.6% |
| 11/8/43 |
-3.6 |
-3.8% |
0.1% |
0.2% |
2.7% |
| 9/3/46 |
-4.6 |
-16.0% |
2.7% |
-0.5% |
-3.4% |
| 5/31/49 |
-3.5 |
-4.4% |
2.5% |
-1.3% |
7.2% |
| 4/6/53 |
-3.6 |
-4.7% |
0.7% |
1.6% |
-0.9% |
| 11/22/63 |
-4.0 |
-5.9% |
5.2% |
6.7% |
11.5% |
| 10/16/87 |
-3.8 |
-10.2% |
-10.2% |
-12.2% |
-10.8% |
| 8/6/90 |
-4.0 |
-7.0% |
1.3% |
-3.5% |
-5.9% |
| 3/30/94 |
-3.6 |
-4.1% |
0.6% |
1.4% |
0.5% |
| 8/31/98 |
-3.5 |
-13.9% |
1.7% |
9.5% |
21.6% |
| 9/17/01 |
-3.5 |
-11.3% |
-3.4% |
4.9% |
9.2% |
| 1/22/08 |
-3.6 (estimated) |
-15.1% |
|
|
|
| |
Average |
-9.7% |
-2.3% |
-1.8% |
0.1% |
Source: Bespoke Investment
Group (B.I.G.). As of January 22, 2008.
According to SentimenTrader, in 1987,
stocks were also moderately oversold heading into
the crash. Then, the market gapped down 5% but
never looked back, even though there were a few
feeble attempts at rallies. Before the next day,
the Fed cut rates and stocks rallied sharply
(+10%) before rolling over to new lows by that
day's close. Stocks finally bottomed when things
were ugly enough for the exchanges to halt
trading. From its intermediate-term high, the
S&P 500 lost 20% at the time of the gap down
on October 19, 1987. Its final bottom registered a
35% decline from the prior high.
Moving forward to 2001, stocks were also
moderately oversold heading into September 11,
2001. This time, though, the Fed didn't wait to
cut rates. There was a larger gap this time, about
8% depending on the index, and stocks mounted a 5%
rally soon after the open on September 17, 2001,
but as in 1987 the rally didn't last. There was
another large-gap down open on September 21, 2001,
which is when the low was finally created. Its
final bottom registered a 28% decline from the
prior high.
Of course, we don't yet know what the close
will look like today, but it's possible today's
situation could result in a 20%-from-high reading,
in line with prior waterfall declines. There is
certainly a chance the Fed could cut rates in an
inter-meeting move [note: I wrote this in advance
of the announcement]. If so, I would expect a bit
of a relief rally [note: as we got]. We're also
likely to finally get some of the contrarian
sentiment extremes that have been lacking as an
upside catalyst. In the meantime, we'll likely see
a bit of forced margin selling during the day
today as some accounts drop below their broker-
and Fed-mandated equity requirements. We might get
some counterbalancing buying interest, but only
time will tell.
I don't have a crystal ball and fear that all the
shoes haven't dropped on the credit crisis. The
problems with the monoline insurers/credit default
swaps/counterparty risk are likely just beginning.
And, although the market is reasonably valued
(certainly relative to Treasuries), as I've
written in many of my latest reports, earnings
expectations for 2008 remain way too optimistic in
my opinion. Until we get a real sense of the
"E" in the "P/E" we are likely
to witness ample volatility.
Early this morning, my colleague, Christopher
Burdick, reminded me of a profound quote from Sir
John Templeton: "Bull markets are born on
pessimism, grow on skepticism, mature on optimism,
and die on euphoria." I'd like to add my own
take on the opposite: Bear markets are born on
optimism, grow on fear, mature on panic, and die
on capitulation. As I've said and written time and
time again, panic is not an investment strategy.
