The Barnard Observer

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Home  Vault  Misc  Contact                                                           c2003-08 Thomas Barnard

Looks like a Big Rally Ahead

The Case for a Rally 

I'm going out on a limb.  I think we're in for a big rally.  Why exactly do I think we’re in for a big rally?

1.  Investors Intelligence reports that 22.2% of investment advisers are bullish, 54.5% are bearish.  These are extraordinarily bearish numbers.  But in the Investors Intelligence world, things are topsy turvy.  Really bearish translates really bullish.

2.  We have seen a number of capitulation days with 15 to 1 negative volume, and one day new lows hit 2600+, which means nearly everything went down.  Capitulation days are necessary to call a low (even if not the final low).

3.  The government took action.  A $700 billion bailout.  Never mind that the action they took probably won’t work.  The important thing for now is that government did take action.  For later consideration is that the capital infusion will go to buying other banks rather lending to business or consumers.

4.  The VIX, which is a measure of volatility, is off the charts to never reached highs of 89.  The VIX was very low before the collapse.  Premiums on options small, everyone was relaxed, nobody very much concerned.  Now everyone is concerned.  Premiums on options very high.  We’ll be climbing that wall of worry.

5.  The oil tax cut rally.  That is how some will view it.  The price of oil has collapsed by more than 50%.  Opec oil production cuts had no effect.  The big Mo (momentum) is now stunningly running against higher oil prices.  But the net effect is a huge tax cut.  I’m thinking Christmas may be down but not horribly down. 

6.  Value Line’s Median Appreciation Potential is 135% in four years.  The last times this index hit this number was right after 9/11, and in 2002 at the end of the bear market.  Needless to say, four years later, the market was much higher.

7.  We’ll probably get another interest rate cut from the Federal Reserve.

8.  If you like mavens, Bill Gross of PIMCO, the largest bond fund, on Friday October 24, 2008, said on CNBC, "From a certain price point here, and we might be their shortly, a bull market could be soon forming."

Opposed to this are:

1.   PE ratios are still very high.  Hulbert reports that the PE for the S&P 500 is still at a lofty 18.  Bad sign.

2.      Richard Russell, who has an extraordinary record, says something along the same lines.  He says the Dow is paying dividends of $323.  To yield the 6% of a classic bottom, the Dow would have to go to 5383.

3.      Buffett is advising people to buy, and he’s no market timer.

The Problem

The problem is that it may only be a trading rally, but it could be good for 3 months or 6 months or maybe even a year.  By then we will have a better take on where the economy is going.  But there is terrible news coming.

1.  The auto industry is in failure mode.  All of the auto companies may fail.  Chrysler is in private ownership, but if they’re doing so well, then what’s all this talk about combining with Ford or GM?  GM has negative book value of over $100 per share.  The company is in intensive care.  It has been badly run all of my adult life.  Kirk Kerkorian is disgorging his stake in Ford.  But of the three, Ford probably has the best chances.  Demand is devastatingly weak.  Most everyone I know is trying to make their piece of junk last longer.  My car is a 1990 BMW with less than 120,000 miles.  Body is good.  I’m in no rush.

2.  The inventory of homes is a disaster.  No one wants to lend, and not that many want to borrow.  The restoration of the tried and true loan standards means less people qualify under the old 20% down, 30 year fixed guideline.  And the problem is that the government’s program in the short term is only designed to help big banks buy small banks, not make loans to home buyers.  Banks buying other banks does nothing for the economy.

3.  Businesses are still laying people off.  Hewlett Packard let go 26,000.  Lehman will be letting go 26,000.  Yahoo is letting another 1,000 go.  The auto industry is letting thousands of people go.  Almost all businesses are letting people go big or small.  Unemployment may cause another round of foreclosures and layoffs.

In 1974, in 1979, in 1991, in 2000, we were not facing quite such terrible stuff.  This is why I cannot conclude that the bottom that was reached is a final bottom.  Stay tuned.  But I think we are in for a rally to start sometime between now and the end of the year.  Perhaps they will call it the Oil Tax Cut Rally, or the McCain Rally, or the Obama Rally, but I think one is in the offing.

I think we must consider the time element.  It looks to be different this time.  Everyone expects that we’ll just hit a low and that will be that, but I would not trust any low that was achieved now because usually the market discounts about 6 months out.  In 6 months I don’t see the bottom of economic activity.

Oil

Over a 100 years ago Rockefeller complained, crude oil “is about the worst commodity in the world to speculate in…It is about as uncertain as railroad stocks.”

The obvious thing is that the spike in oil prices was mostly speculation.  The thing that we haven’t heard is who lost.  Some hedge funds must be sorely hurting.

The price will go back up, but it will take healthy economies to do it, and that is a ways away.

Gold

Well, gold is going down for the moment, but the government is borrowing a lot of money.  Well, let me rephrase that.  It’s not just a lot of money, it’s a boatload of money.  No one knows what this kind of borrowing will do to the ship of state.  And probably no matter who is elected, they’ll borrow more.

Borrowing to put up alternative energy projects is one thing.  The payoff is clear and economic.  Borrowing to help the indigent?  Well, they’ll spend the money.  There is a short term payoff for the economy, but no long term benefit.  Borrowing for wars, well, it doesn’t look like there is much benefit.  Iraq is still producing less oil than before the war, and our government has not benefited from the $74 billion Iraqi government surplus.  But not to be bothered, we borrowed the money from our traditional ally, China.  Yes, I’m being ironic.  Too much Jon Stewart.  All in all, I’m rating borrowing for wars is a negative for the economy.

For now gold is going down because recessions/depressions bring prices down.  Oil is going down.  A lot of commodities are going down.  Stay tuned.

Duck Hunting

I think the selection of investments resembles duck hunting.  You want to aim your money to a place that is going to catch up with some trend. 

What’s wrong with GE?  Yes, they have to clean up the financial part of their picture, but as far as I know they have never lost their AAA status, even before Buffett added his imprimatur.  He's always like their CEO, Jeff Immelt.  But their other pieces look good.  Jet engines, power equipment, wind turbine business.  Entertainment businesses don’t suffer in recessions like other businesses.  It pays 6%.  I think that helps to put a bottom under it.  People pooh-pooh dividends, but I think they’re going to be popular, especially when there is no outlook for a really strong sustained market.

In spite of the fact that Suntech is probably down 50% from the last time I mentioned it, the solar business was backed by the continuation of Federal subsidies, and I think that continues for the next two administrations.  By the end of that time, research and economies of scale maybe make it competitive with any energy source.

Other stocks that I like are remarkably low:  Cisco, Whole Foods Market.  Apple looks pretty low.

But I have to qualify my recommendations.  Reality check: My ten bagger is turning out so far to be more like a one tenth bagger.

Beware, this up call could be early.

October 26, 2008 (Dow 8378)

edited October 27, 2008