What a week we have just ended! Despite all the negative headline news and an 8.9% sell off on Monday as some investors chose to book their profits from the previous week, the market finished the week down only a little more than 2%. It is even more impressive considering the rally on Friday is from a loss of over 3% all the way to a gain of more than 3.5%, a complete reversal on above average volume. It suggests that most bad economic news has already been discounted in the market. It also suggests that the lows made on Nov 20th, which was largely due to fears of a potential failure of Citi, may indeed be the lows of this round of bear market. As we mentioned in our previous market comments, we think the lows made on Nov 20th should be the lows for the financial crisis unless the economy is sinking into another “Great Depression”. Judging from today’s job report, it seems that the US GDP is shrinking at a pace of 6 – 8% in Q4, compared with the current view of a drop of 4%.
Let’s take a look at the three key indicators: 1. VIX: closed at 59.93 compared to 63.64 yesterday. Conclusion: improving; 2. The euro/yen cross: closed at 118 compared to 118 yesterday. Conclusion: holding; 3. The TED spread: closed at 218 bps compared to 219 yesterday. Conclusion: holding.
All major sectors ended the session in green led by financials and technology. The CRB commodity index declined 4.3%, extending its month-to-date drop to 13.9%. Crude price has declined over 72% during the past five months and was closed barely above $41. The US dollar was mixed against most major currencies while treasuries declined for the first time in a long while. The three-month US LIBOR was little changed at 219 bps. The VIX index dropped 3 points. The market breath was positive on both NYSE and Nasdaq and the volume was heavier compared to the previous session.

The market dropped sharply on this Thursday. By close, all three major indices posted a loss in excess of 2.5%. Similar to the previous two sessions, the defining moment occurred during the final two hours trading. But unlike the previous two days, investors chose to dump shares ahead of tomorrow’s key non-farm payroll report. Some on the Street have expected a number far worse than the consensus of a loss of 320K. With the fear of a deepening recession, bond yields kept hitting new record lows. Actually bond price can be the biggest bubble that is set to burst in 2009. Based on the current yield curve, investors are willing to accept a mere 3% annual interest rate for 30 years!! I really don’t think that inflation will always be negative for the next 30 years considering the power of the central banks these days. In other words, investors are willing to accept less than 3% real return for 30 years. Something truly incredible! But just as investors were blindly chasing internet and telecom shares and were willing to pay over 100 times P/E when Nasdaq was traded over 5000 points, investors can pay incredible prices for bond. One bubble leads to another bubble and some people just never learn.
Let’s take a look at the three key indicators: 1. VIX: closed at 63.64 compared to 60.72 yesterday. Conclusion: worsening; 2. The euro/yen cross: closed at 118 compared to 118 yesterday. Conclusion: holding; 3. The TED spread: closed at 219 bps compared to 219 yesterday. Conclusion: holding.
Most major sectors ended the session in red led by energies and technology. The CRB commodity index declined 3.7%, extending its month-to-date drop to 10.0%. Crude price has declined over 70% during the past five months. The speed of the drop was indeed incredible. But the champion in this area did a much great job than crude. The BDI index, which is a great indicator for global economy, tumbled 94% in less than half a year and even at just a fraction of its peak value, it still works hard towards the downside day-by-day. At 666, the index has dropped below its 1987 level. The US dollar was mixed against most major currencies while treasuries continued to rally with yields hitting record lows. The three-month US LIBOR was little changed at 219 bps. The VIX index jumped 3 points. The market breath was negative on both NYSE and Nasdaq and the volume was lighter than the previous two sessions.

The market is in a tug of war between fears of a deep recession and hopes of a recovery down the road these days. Similar to yesterday, the trading activity was extremely volatile. Fortunately for the bulls, a rally in the final hour lifted the market sharply higher for the second straight session. By close, all three major indices were higher by at least 2% and the two-day rally has gained back over two thirds of the losses on Monday. It is even more impressive considering that today’s rally happened in a session with almost no good economic news, which suggests that the rally may be more sustainable compared to the previous ones.
Let’s take a look at the three key indicators: 1. VIX: closed at 60.72 compared to 62.98 yesterday. Conclusion: improving; 2. The euro/yen cross: closed at 118 compared to 118 yesterday. Conclusion: holding; 3. The TED spread: closed at 219 bps compared to 216 yesterday. Conclusion: holding.
Most major sectors finished the session higher led by healthcare and industrial. The CRB commodity index declined 1%, extending its month-to-date drop to 6.5%. The US dollar was mixed against most major currencies while treasuries continued to rally with yields hitting record lows. The three-month US LIBOR was little changed at 220 bps. The VIX index dropped 2 points. The market breath was positive on both NYSE and Nasdaq and the volume was comparable to the previous two sessions.

The market rebounded nicely today. At close, all three major indices finished the session higher by at least 3%, regaining 40% of the loss in the previous session. Once again, the market is driven by emotion rather than fundamentals. Some may attribute today’s rally to GE’s business update, which came better than some had feared. But we should note that the market was sold off badly in the early afternoon trading before a final hour rally. In other top financial news, both GM and Ford presented their detailed plan to Congress of how they are going to use the proposed $25 billion in loans from the government. Earlier, each of the “Big Three” announced decline in November sales by more 30%.
Today we are going to take a look at some monetary indicators and how the market reacted in several recessions following the WWII. Of course each recession has its uniqueness and is caused by different reasons. For example, the 1974 – 1975 recession was largely due to the first “Oil Crisis”; the 1981 – 1982 recession was the victim of 20%-plus interest rate as the Fed was desperately trying to hold down inflation at that time. But using history as guidance, we can at least know how to put the upcoming bad news into context– hopefully they may not be as bad as many have feared.
Start with the interest rate. Here I’m going to use the yields on the 10-year Treasury (it should be noted that the 30-year T-bond was used as a benchmark for most of 1980s and 1990s until the Treasury department decided to stop issuing them in late 1990s). The former Fed Chair Alan Greenspan favoured a model called the Fed Model, which basically compares the stock market return with the yields on the Treasuries. The fans of the model argue that when the yields on the Treasuries are high relatively to the yields (or earnings) in the stock market, investors will be better off by investing in the Treasuries. For example, if the yields on the Treasuries are 20%, then why should one invest in the stock market even if the average P/E in stocks is only 10 times? Back in December 1996 when Greenspan first used “irrational exuberance” to describe the overvaluation in the stock price, the average P/E in stocks was 20 times while the Treasury bond at that time offered almost 7% yield. In other words, Treasury was a better choice in the eyes of Greenspan at that time.
During the 1974 – 1975 recession, the average yields on the Treasury were around 8%. According to the Fed Model, investors should not buy stocks unless the average P/E in the market was below 12.5 times (1 / 8%). So what was the average P/E at that period? The lowest P/E that the market touched during the period was 7.1 times while the average was around 10 times. Therefore the discount that investors received from investing in stocks was 20% ( (12.5 – 10) / 12.5 = 20%). During the 1981 – 1982 recession, the average yields on the Treasury were around 14%. In other words, investors should not pay more than 7 times earnings for stocks if they follow the Fed Model. So what was the average P/E at that time? The lowest P/E in the period was 7.5 while the average was around 11. Investors actually paid more than they should pay for stocks. Interestingly enough, if one happened to invest in 1982, he or she would almost catch the bottom of the 18-year bull market lasting until 1999. Quickly move to today’s situation. The yields on the 10-year Treasury were average below 3.5% in this round of recession(the latest yield was only 2.7%), leading to a fair P/E of around 30 times. The average P/E in the S&P 500 so far was around 18 times. At least based on the Fed Model, investors get almost a 40% discount by investing in stocks.    
Next we are going to take a look at Monetary Aggregates. More specifically, we will focus on M2, which measures money supply that includes M1(cash and checking account) plus savings and small time deposits, overnight repos at commercial banks, and non-institutional money market accounts. Why Monetary Aggregates are so important to economy? As we all know, banks are in a business to take in deposits and make loans (of course, banks are doing more businesses than that these days but that’s still the most fundamental role banks should play). With more deposits, banks are able to make more loans. When money is ample (therefore higher Monetary Aggregates), banks are more willing to lend, leading to more economic activities. We should also point out that central banks can use various tools to affect the Monetary Aggregates. In the long run, increasing Monetary Aggregates is the biggest reason behind inflation.
During the 1974 – 1975 recession, M2 slowed from an average of 9.9% in 1973 to 7.6% or a drop of 23%. During the 1981 – 1982 recession, M2 increased from an average of 8.0% to 9.1%, a gain of 14%. In the current recession, M2 is increasing at a 6.3% annual pace compared with an average of 5.7% in 2007. We can foresee that with the massive steps taken by the Fed recently, M2 will increase even faster in coming months, which hopefully will make banks more willing to make loans.
Finally we are going to take a look at how the stock market behaved those recessions. Here I’m going to use two measures. First, I’m going to calculate the biggest drawdowns, i.e., the percentage change from the peak to trough. Second, I’m going to calculate the lengths of the bear markets, defined as the period that the market stayed below 20% from the previous peak. I will use the S&P 500 index here.
During the 1974 to 1975 recession, the biggest drawdown was 48.2% (the peak and trough dates are Jan 10, 1973 and Oct 3, 1974 respectively). The length of the bear market was a little longer than 2 years (the starting date was Nov 27, 1973 and the ending date was Jan 9, 1976). During the 1981 to 1982 recession, the biggest draw down was 27.1% (the peak and trough dates are Nov 28, 1980 and Aug 12, 1982 respectively). The length of the bear market was 6 months (the starting date was Feb 22, 1982 and the ending date was Aug 19, 1982). In the current recession, the biggest drawdown (assuming the lowest is indeed the lowest) has already reached 51.9% (the peak and trough dates are Oct 9, 2007 and Nov 20, 2008 respectively). The length of the bear market is 5 months (the starting date July 9th 2008). If history is any guide, the drawdown should be big enough to make the lows but investors should not expect to see the bear market end any time soon.
Let’s take a look at the three key indicators: 1. VIX: closed at 62.98 compared to 68.51 yesterday. Conclusion: improving; 2. The euro/yen cross: closed at 118 compared to 118 yesterday. Conclusion: holding; 3. The TED spread: closed at 216 bps compared to 222 yesterday. Conclusion: holding.
All 10 major sectors finished the session higher led by financials and industrals. The CRB commodity index declined 2% with crude now off $100 from its peak. The US dollar was mixed against most major currencies while treasuries continued to rally with yields hitting record lows. The three-month US LIBOR was little changed at 221 bps. The VIX index dropped 6 points. The market breath was positive on both NYSE and Nasdaq and the volume was neutral.

The Thanksgiving-rally music stopped in a rather harsh way. Following the best weekly performance since 1974, the market experienced one of its worst sessions in recent history. In fact, the Dow’s 680-point plunge made it the fourth worst point decline in its whole 112 years’ history. As we suggested earlier, the market seemed to live only with either the best or the worst these days. The main reason behind today’s broad decline was concern over a deep recession. But is that something new? The National Bureau of Economic Research, or NBER, announced today that the US entered a recession since December 2007. NBER has a reputation of making announcements of recession so late that when they finally make up their mind the recession is almost over. The last time when they made an announcement back in 2002, the recession was actually finished in November of the previous year. But this time things can be different as we are facing one of the worst economic meltdowns since the end of the WWII. In one of the first economic reports scheduled to be released in December, the ISM index dropped to the lowest level since 1982. Within the index, new orders contracted for 12 consecutive months to the lowest level since June 1980; The Prices Index’s reading of 25.5 was the lowest since May 1949.
As we are now officially in a recession (thanks to NBER’s announcement this morning), I’m going to make some comparisons between some other notable recessions after the WWII and the one we are experiencing right now. The main reason that I don’t make comparisons for pre-WWII is many key economic data are unavailable for that period. Tomorrow I’m going to compare some policy makings (e.g, interest rate, money supply) and how the stock market reacted during those recessions.
Start with the ISM index, which measures the nation’s manufacturing activities. It should be noted that manufacturing industry plays a less and less important role in the decades following the WWII. In the 1981 – 1982 recession, the ISM index stayed below 40 for 13 consecutive months. In the 1974 – 1975 recession, the ISM index stayed below 40 for 6 consecutive months and lowest was 30.7. So far in the current recession, the ISM index was only below 40 for 2 consecutive months.
Move on to employment, which we are going to get the latest information this Friday. In the 1974 – 1975 recession, the unemployment rate stayed above 8% for 12 consecutive months and the peak was 9%. In the 1981 – 1982 recession, the unemployment rate stayed above 8% for 27 consecutive months and the peak was 10.8%. So far in the current recession, the unemployment rate is 6.5% and is forecasted to climb to 6.8% in this Friday’s report.
Next we are going to take a look at the Housing Starts. Housing is the root problem of the current recession. In order for the financial markets and the broad economy to find a true bottom, the housing market has to stabilize first. In the 1974 – 1975 recession, housing starts plunged from a peak of 2.4 million annualized units to a trough of 709K units in May 1975. It stayed around that level for 3 consecutive months before a rebound started. In the 1981 to 1982 recession, housing starts once again fell below 800K and stayed there for 4 consecutive months before a rebound started. In the current recession, we just moved below 800K level in October and it should be no surprise if we see several more months’ reading below 800K.
Of course when we discuss macro economy in the US, we cannot finish without discussing personal consumption or retail sales. Things are also getting trickier here as we need to distinguish between real spending and nominal spending, the difference of which is what we call inflation. Since the monthly retail sales data provided by the US Census Bureau are in nominal terms pre-1992, I’m going to use the personal consumption sector of the real GDP instead. In the 1957 to 1958 recession, the real consumption declined 10.4% at its worst. In the 1974 to 1975 recession, the real consumption declined 4.7% at its worst. In the 1980 to 1981 recession, the real consumption declined 7.8% at its worst. In the 1981 to 1982 recession, the real consumption declined 6.4% at its worst. In the 1990 to 1991 recession, the real consumption declined 3.0% at its worst. In the 2001 recession, the real consumption declined 1.4% at its worst (that’s why it is one of the shallowest recessions on record). So far in the current recession, the biggest real consumption drop happened in the previous quarter and it was a decline of 0.3%. If history is any guide, we are going to see much worse data ahead.
Let’s take a look at the three key indicators plus the one credit indicator I added several weeks ago: 1. VIX: closed at 68.51 compared to 55.28 last Friday. Conclusion: worsening; 2. The euro/yen cross: closed at 118 compared to 121 last Friday. Conclusion: worsening; 3. The TED spread: closed at 222 bps compared to 222 yesterday. Conclusion: holding. 4. The iTraxx basket spread: closed at 642 bps vs. 728 bps in the previous week. Conclusion: improving. In summary, the market remains in “dangerous” zone although the credit market condition has improved significantly during the past few weeks. We should also point out that VIX has been above 50 for all sessions since October 6th except Nov 4th, when it was closed at 47.73. Back in the 2001 to 2003 bear market, the peak of the VIX was only 45.
All 10 major sectors finished the session lower led by financials and basic materials. The CRB commodity index declined 3.7%. The US dollar was higher against most major currencies while treasuries continued to rally with yields hitting record lows. The three-month US LIBOR was unchanged at 222 bps. The VIX index jumped 13 points. The market breath was negative on both NYSE and Nasdaq and the volume was neutral.