From Green Shoots to Brown Shoots

Economic numbers are becoming less good. In some cases they are downright bad. Back in the spring of 2009 many analysts were commenting that the news was getting less bad, therefore “green shoots” were starting to demonstrate new life for the markets. That turned out to be true. Whatever the reasons were: trillions of dollars of government stimulus, ending the “mark to market” (real) accounting standards on bank held mortgage and asset backed securities, or just a very oversold market. The market retraced 61% (An amazing Fibonacci coincident for those technical gurus) of the downtrend that started in 2007.

Now we are seeing a mirror image of that positive news. Jobless claims are rising back to 500,000. GDP revisions are becoming lower, and most every other economic release is slowing or slipping back into negative growth. This is not good! Could those green shoots be turning brown? The markets and the economy here in the US have never gained enough strength to stand on its own.

It was reported by Fidelity Funds on Friday that a record number of people are raiding their 401(k) assets. Fidelity is the largest manager of 401(k) plans with 11,000,000 participants. They report that in the second quarter alone 62,000 individuals have applied for a hardship withdrawal. That figure is up almost 40% from last year number. To be eligible for a 401(k) hardship withdrawal, individuals must demonstrate an immediate and heavy financial need, according to IRS regulations. Certain medical expenses; payments to prevent eviction or foreclosure on a primary home; burial or funeral expenses, meet the IRS definition and are permitted by most 401(k) plans. A key concern is that these withdrawals are just that, they are not loans. This can have a significant impact on someone's overall retirement plan. It seems many individuals are more concerned about getting through today than they are worried about their retirement. What message does that send about the strength of this recovery?

Stimulus has run its course and the situation seems to be sliding downhill. There is talk of more stimulus – recently there has been a lot of chatter about lowering mortgage rates for everybody with a Fannie Mae or Freddie Mac held mortgage -which includes 90% of all loans. While that would definitely help put more money in a lot of people’s pockets, what would that do for everyone else? What about renters? How about people who already lost their homes in foreclosure? How do they benefit? The bigger question is how would this program be implemented? Would everybody have to requalify or would it blanket everybody with a mortgage? Finally, where would the staffing come from to complete this herculean task? An easier and more equitable method of putting money into everyone’s pocket would be to just give a rebate – send them all a check! However, with the government deficit as large as it is and still rising, how likely is that? Not very!

The markets are now trending down on the short (weeks), medium (months), and longer term (years) timeframes. There have been many different ominous technical patterns that have occurred such as black crosses, double tops, head and shoulder patterns, and most recently a confirmed Hindenburg Omen. What does all that mean? For starters all these technical patterns don’t guarantee anything. They just have historically demonstrated an above average possibility of negative future price performance for the markets.

It is important to examine the big picture. When there are several pessimistic technical patterns, combined with numerous gloomy fundamental economic reports the odds are higher that the future market direction could be down. Even the Fed is stressing caution about the next direction for the economy. We are not alone. Many other countries in Europe are also experiencing a financial crisis. This problem has not gone away and appears to be reversing directions- getting less green.

I hate being bearish with my commentary. It comes off as being unpatriotic and that is hardly the case. People who have not known me very long think that I am a perma-bear. That also is not the case. I became negative in mid 2007 and since then the markets (as measured by the S&P 500) are down 32%. The bulls argue that with real estate so tenuous and bond yields so low that stocks are the only game in town. I think they fail to realize that cash would outperform if stocks yield a negative rate of return (The S&P is down 4% YTD).

Another bullish claim is that the stock market has a low valuation based on historic PE ratios. On actual 12 month reported trailing earning, the S&P 500 is trading at a PE of 15. It is widely acknowledged that this past recession was the worst since the Great Depression in the 1930’s. Yet there have been a couple of instances where the markets PE ratio was in the single digits since that Depression, as the risk appetite for each dollar of earnings was diminished. It was as low as seven at the 1974 – 1975 market bottom. PE ratios can vary with the mood of investors. So while I think the market can be called fairly valued today, that can change very quickly as investor sentiment adjusts.

The levels to watch are 1040 and 1132 on the S&P 500, 580 and 678 on the Russell 2000, and 2140 and 2342 on the NASDAQ. The first number in each case would signal a potential further market decline, perhaps precipitously so. The latter number is where the market would need to go for me to become bullish. We are heading into the fall of the year (no pun intended). Historically the next two months are the most difficult for the markets. Both technical and fundamentals are flashing warning signs. It may be prudent to apply caution in the near term.