Saturday, July 12, 2008

U.S. Stocks To Recover?

Greg Mankiw notes that newsletter pessimism have reached the highest level since June 1994 and also notes that June 1994 was a very good time to buy (The great tech stock bubble started in 1995). Confirming this, my good friend Daniel Halvarsson's favorite indicator, bullish percent, also shows that stocks are oversold right now, with the bullish percent falling to 27, below the 30 threshold for oversold.

Thus, a short-term recovery in stocks after the 14% decline since May 19 seems likely soon. With the worries created by Fannie Mae's & Freddie Mac's problems and the collapse of IndyMac, stocks may fall on Monday and perhaps a few days more, but a temporary bottom and following rally nevertheless seem near. However, because stocks are still fundamentally overvalued and because the underlying economic fundamentals are deteriorating, this rally will likely be another sucker rally. And with money supply growth showing signs of decelerating and with virtually all of it going into bidding up commodity and other goods prices, this sucker rally will likely be weaker and shorter than the one that started in Mid-March.

8 Comments:

Anonymous Larry said...

Stefan, the weak dollar might give some push upwards for American earnings this week. But I think we need more panick before the next bear-market rally can start. Maybe we will get it the panick on Friday when the banks come out?

Secondly, looking at money and credit growth in USA and UK it looks dismal. Deflation camp is maybe right? If so, central banks should take it easy in tightening money even further?

8:40 AM  
Blogger stefankarlsson said...

Larry, stocks are already oversold, which means that the conditions for another sucker rally is already present. That doesn't mean they can't fall for a few more days and make it even more oversold, but it seems safe to say that the rally will come very soon.

As for money and credit growth, these numbers aren't yet as deflationary as the deflationist camp would have us believe for reasons I explain here. My prefered money supply measure, MZM, is in fact still growing. However even MZM growth have started to decelerate, which is yet another reason to bearish on stocks in the medium term. If that trend holds, the case for higher interest rates weakens of course. However, this doesn't change the fact that the deflationists were wrong until now, and the lagged effect of the previous high growth rate means that price inflation will remain high and even rise for a while. However, the commodity price rally will weaken and the outlook for stock and house prices will be even more bearish.

12:31 PM  
Blogger Sophist said...

I agree with your analysis basically. Dow has some support at around 10,700 from where we can see a 38.2% Fibo retracement back to around 11,600.

But this statement of yours puzzles me: "However, because stocks are still fundamentally overvalued"

How do you justify it? You may be right, I don't know...

4:27 PM  
Blogger stefankarlsson said...

I wrote about how stocks were fundamentally overvalued when I predicted that stocks would fall back in May 20. Stocks are of course somewhat cheaper now then they were then, but they are still above the historical average in terms of valuation levels.

4:53 PM  
Anonymous Larry said...

Thanks for your comment Stefan. Sophist: I don't think you are aware of the almost hyper-inflationary environment in emerging markets, which is now turning due to tightening. That international growth holding up Dow Jones companies is a mirage. This will get very very nasty on the downturn.

5:07 PM  
Anonymous Anonymous said...

Stefan, what´s your opinion on decoupling today. Can the BRIC economies keep up growth despite the crisis in the US.

6:02 PM  
Anonymous Daniel Halvarsson said...

Stefan, I think you are correct in your analysis. I wouldn't be surprised if we got a reversal in the bullish percent from these levels. Remember, that that was precisely what we saw in March, when the last sucker-rally took off from a reading of 28 % in New York Stock Exchange Bullish Percent indicator.

9:58 PM  
Blogger stefankarlsson said...

Anonymous:I'll return to that issue later, but for now, let's just say the numbers indicate more of decoupling than recoupling.

10:21 PM  

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