A Very Likely Scenario Is For Rate Cut To Cause A Short Term Bounce In Stock Market:
In the past the stock market normally advanced quickly on 1st or 2nd cut of rates by the Federal Reserve. If rates are cut on Tuesday, then this will be the 3rd cut. Our expectation is for there to be a market rally for a few days or a couple weeks. Then we expect the market to turn down and move into lower territory. In other words we believe there is a strong likelihood of a Bear Market Rally, but we do not believe this is the end of the Bear Market. Those needing to raise some cash could liquidate some stocks if the advance occurs, but I do not believe this is a time to be increasing commitment to the stock market.
Why Expect Immediate Advance In Stock Market (if it occurs) To Be Short Lived:
There are two fundamental reasons for believing that the Bear Market will continue, and it will take more cuts in the Discount and Federal Funds rate before the bottom is in place. The first problem is that levels of market valuation remain high and are not consistent with market bottoms. For example, the P.E. ratio of the S&P 500 climbed from 16 at beginning of 1995 to 36 (a 50-year record) at the top of the market in March 2000. The P.E. Ratio for the S&P 500 has come down to 22.6 from 36, but is still way above the average of 16.2 P.E. from 1970 to the present (see chart). In addition, as stock prices soared the dividend yield has fallen from 6% in 1980 to a little over 1% a few weeks ago (now 1.36%). In other words, for the market to put in a real bottom we would expect the P.E. Ratio to fall from 22.6 to around 15, or a decline of another 35%.
The NASDAQ Is Even More Overvalued:
The NASDAQ climbed to a P.E. of 200 at the top of the market in early 2000 and has fallen to around 80. The average PE for the NASDAQ is close to 35 times earnings so the NASDAQ could fall by another 50% to bring it down to its historical average.
Other Problems Hanging Over The Stock Market:
We have gone through the longest economic expansion in history that started in March 1991. The almost 10-year long boom has presented great economic times for many Americans. But at the same time there have been some excesses that have come along with the economic boom. To participate in the good times, consumer credit has exploded with credit cards being extensively used to acquire more of the good life. Home equity (% of equity in a home to the value of the home) has fallen sharply as home owners have refinanced their homes and increased their mortgages, while others have taken out secondary mortgages on their home to finance consumption. Huge credit card debt and home mortgage debt is a hangover from the longest expansion in the history of our economy.
Danger In A Near Zero Savings Rate:
The personal savings rate during the 1960s, 1970s, and 1980s ran from 7%-8%, but in the booming carefree 1990s the personal savings rate has fallen to near zero. With the implosion of the stock market and family wealth and job uncertainty (and rising unemployment if economy further tightens), it can be clearly anticipated that the personal savings rate will start to rise. When everything is bright (good jobs, easy credit, and growing retirement and investment portfolios), then people will cut their savings rate (as has occurred during the booming 1990s). If the saving rate were to start climbing from the 0-1% level now back to 7%-8% (the norm), then this could take 2%-3% out of GDP for several years and cause stagnation much like has occurred in Japan. If the black economic clouds grow, then Americans will pull back from their spending ways and start again saving for a rainy day. We could become more like Japan where personal savings has rapidly increased over the last 12 years while the Japanese economy has been in the tank.
Summary:
We expect the Federal Reserve to cut rates when it meets tomorrow and this is in our opinion the appropriate policy. In the past cuts in the Fed Funds and Discount Rate has been very bullish for the stock market. We believe there is a good chance of a Bear Market Rally if the Fed cuts rates on Wednesday. But after a few days or a couple of weeks, we expect the market to move to new lower territory. Primary reasons for this opinion is that levels of market valuation remain fairly high (not what are usual at market bottoms). In addition, there are excesses associated with the record long economic boom that will have to be worked out before the economy can again advance strongly with stock prices climbing.
*****
Flash forward to today!!! (Duratek)
We now have negative saving rate, consumption was NEVER curbed during the 2001 Recession nor anytime during the 2000-2003 Bear Market, only more excesses more piled up, more debt etc. We are LESS prepared then to deal with any economic adversity.
Higher energy costs, inflation in areas of consumer needs not wants make the disposable income scenario much worse, as wages have FAILED to keep up with even basic inflation.
Real estate has begun to deflate, a major driver of economy, and is why I believe the commodity prices have begun to decline, and may be entering a bear market.
Chinese stock market is in bear market and recently plummeted by 5%.
VIX ratio is now in an uptrend and we have experienced TWO 90% DOWN DAYS in stock market in past 30 days, VERY good chance Bear Market is BACK!!!!! The risk is to the downside, and we have enterred the weakest 6 months of stock market returns.
Stock market leadership is nowhere to be found, MANY Dow and SPX stocks near 52 week lows, any near 52 week highs continues to diminish near record levels.
IMHO, with cyclical bull rally in very elder stages, extreme caution is now advised. Consult with your financial professional to see if your portfolio can withstand the return of the Bear Market should that be the reality.
The financial mechanisms are surrounded by GS cronies, let's see what PPT team can do.
Duratek
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