This blog post originally appeared on RealMoney Silver on July 7 at 7:35 a.m. EDT.
One would think that a tradable bottom is close at hand based on the
in many of the classic credit market indicators, an inflating negativity bubble (oscillators are moving into deep oversolds, the five-week moving average of advancing stocks is at the lowest level since 2002, Lowry's selling/buying pressure is at an extreme,
market letter bears at 44.8% is at the highest reading in 12 years,
bears are double bulls similar to prior trading lows, Ed Hyman's ISI hedge fund survey reveals a lowly 45% net long exposure, expanding put/call ratios, etc.), the general lowering of profit expectations from even the most bullish cabal, and the speed and magnitude of the recent decline. Thin-reed indicators out of the media also signal the possibility of a rally (e.g.,
bear cover this weekend and the somber preoccupation with a 20%
drop as a tipping off point to a bear market is the polar opposite of
DJIA 14,000 celebrations).
Many stocks are cheap.
It is also clear, however, that the road back in stock prices will be choppy and uncertain: There has simply been too much damage done to consumers, equity holders and the financial system. By now, most of the bullish (perma or otherwise) strategists have been discredited, and bottom fishers have been unrewarded.
Equities have broken through the
1,275 level, which I previously thought to be the approximate downside risk for stocks over the next 12 months. Perhaps it should not have been that surprising -- in a sense, the swiftness of the recent market slide is the mirror-image of the spring 2007 advance.
There seems to be near unanimity that the price of oil has a stranglehold on stock prices, and, at this point, even a $10 to $25 dollar drop will produce a price level that will likely linger as a tax on consumers, a drag on personal consumption expenditures and is almost certain to plague corporate profit margins for some time to come. A period of investor apathy/disinterest seems to be a likely backdrop and will serve as a lingering drag, discouraging both individual equity accumulation -- mutual fund cash flows will moderate even further -- as well as higher institutional allocations into asset classes that correlate closely to equities.
Hedge funds (which, as I previously mentioned, are conservatively positioned today) are likely to remain risk-averse; the asset class will contract in size as many of the smaller members of that community fold and some medium-sized hedge funds lose critical mass (and are redeemed). Importantly, growth in the fund of funds industry (i.e., the straw that stirs the drink of hedge funds) will likely decelerate (and could even decline) as the extra layer of fees is questioned by some investors in a substandard return environment.
If corporate profits are the lifeblood of equity prices, I suspect the message of the recent bear market is that a relatively extended period of depressed profits into 2010-2011 will restrict the upside regardless of how inexpensive stocks appear relative to short-term and long-term interest rates.
From my perch, the likelihood of a rigorous rebound in stocks has now been reduced, and investment performance will be importantly differentiated by specific industry selection rather than by judging the market's general health in making cash/invested position decisions. On that score, I suspect last week's weakness in industrial materials, selected energy (e.g., coal) and dot-corn (agricultural) is a first shot across the bow to developing sector underperformance, while previously depressed sectors (e.g., financials, retail) could be candidates for a rebound.
All this said, the markets, for now, are, to some degree, in the hands of risk managers (not portfolio managers) and trigger-happy and (some) panicky/desperate hedge funds that are fighting for their lives, so there is no telling what will happen.
Unpredictability, volatility and emotion seem likely to rule the day over the summer of 2008, but, as the wiseman once said, this too shall pass.
Doug Kass writes daily for
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Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.