Over the course of the last two (2) weeks the overall stock market has experienced one of its worst declines since the end of the Great Depression. By any normal measure the market is greatly over extended to the downside, however we are obviously not in a normal market correction. I routinely look at 200-300 (sometimes more) stocks in preparation for making the stock recommendations found in the Sterling Prime Stock Letter; what amazes me is the number of stocks that have lost 60-80% of their value in the last 2 weeks. Many companies have seen their stock prices return to levels of 5-10 years ago! It really begs the question of when the bargain hunters and value investors begin to start buying????? Followed by the question of why they are still sitting on the sidelines????? Well, I am not running one of those portfolios so I can't claim to know what they are thinking, but if they are looking at the same charts as I am; then my guess is that they are waiting to see if the market drops down to its post 9-11 lows set in late 2002 and 2003. That puts the Dow Jones Industrial Average below 8,000, possibly as low as 7,200. Oh, and one other thing to make note of; this is the start of "earnings" season, so some better than expected earnings reports this week could start to turn the market around.
When I was looking at the charts from Friday's market activity, I noticed that the KBW Banking Index "BKX" appears to have put a double bottom in place. This is normally a very bullish trading signal. Which may indicate that the government's efforts to shore up the banking sector may be starting to have a positive effect on things. While trouble in the banking sector certainly got us into this mess, and it may still yet help lead us out of this mess, a lot of damage has been done to the financial markets in the process which also forces us to ask what else may be weighing on the markets?
In the July 21st edition of the Sterling Weekly I listed five (5) factors I thought were weighing on the market. They were Financial System Weakness, High Oil Prices, Dollar Weakness, Taxes, and Political Uncertainty. I discussed financial system weakness in the August 13th edition, and the price of oil in the September 9th edition, and Dollar Weakness in the September 15th edition, of the Sterling Weekly. Since then we have seen the price of Oil fall by almost 50%, and the US Dollar strengthen against the other major currencies of the world. I think what is ailing the markets right now is:
1. Uncertainty over the future of the Financial System: I wrote about the uncertainty of the financial system in the August 13th edition of the Sterling Weekly, and to be quite honest no one saw the coming crisis with the demise of Lehman Brothers, Fannie Mae, Freddie Mac, and AIG. Well maybe the editorial staff of the Wall Street Journal saw some of it coming, but not even they ever talked about anything of this magnitude. Now the big question is what will our financial system look like in the future? What companies will be left? And which ones will be gone? Even more importantly, what will the role of the government be in those that are remaining? How much longer will these companies have to endure unprofitable quarters? And when will they turn profitable again? Until these questions are answered, look for this sector to remain depressed and for concerns over the health of this sector to spill over into other sectors of the economy. If I were to make a guess, unless their is a miracle and President Bush breaks his silence and really gets assertive on a pro growth, regulatory reform program, none of these questions will be answered before the election on November 4th.
2. Lack of Credit and what that will do to the Economy: A lot of people who are not involved in the public markets do not understand this, but one of the very clear messages of the markets is that we are entering a severe deflationary period that is being driven by an absence of credit. Businesses are simply not going to be able to borrow the funds/money they need to expand their operations or even operate at their current levels. This is going to cause a severe contraction in the economy.
3. Political Changes coming with the US Election: One way or another this election is going to bring massive changes to the United States and the world. Our choices in this year's election are between a liberal politician and someone who has frequently in the past been labeled a populist Republican. Regardless of who wins, things are going to be very different from the conservative George Bush our current President. Our Presidential candidates have vastly different beliefs on the role of government in our lives, and as a result different sectors of the economy will fair better under the presidency of one candidate, and others will be the worse off. Unfortunately both candidates have also made statements that are very negative for certain segments of the market. I think the market is starting to take a hard look at what sectors of the economy are going to perform poorly based upon who it thinks will win the election, and those sectors are the ones that are being the hardest hit. In next week's edition of the Sterling Weekly, I am going to publish my list of which sectors I think will perform well and which will do poorly under each of the candidates if they were to become President. Since each candidate has vastly different views on the tax structure in this country I will include in my discussion on the tax system in this country, and with that discussion I'll conclude my comments on the five (5) issues that I felt were weighing on the market that I listed in the July 21st edition of the Sterling Weekly.