S&P 500: 1350 Revisited

The Spoo blew right through 1350 last week, settling at 1325 on Friday. Tonight it had a 50 handle at its low, but the 50 handle had a 12 in front of it. Scary. I told a friend on November 6th that I felt we were going to embark on a bear market that day, on a day when the Spoo opened at 1505 and settled at 1520. Now the thing is that the market did go nearly straight down from that day to 1406. But then up to 1:15PM Central on December 10th it went all the way back up to nearly 1525. Then the fed meeting adjourned and from there, with only one meaningful bounce, we have dropped more than 250 points. In the process the Spoo has for the first time since October 2002 made a major new low that is lower than its prior major low. That is how I define a trend, in this case a bearish one. That trend was not confirmed technically until Wednesday of last week. Now a 20% move that is very nearly straight down is a phenomenal move, a huge huge move.

There will be a counter move. If not tomorrow then sometime later in the week. This bounce will likely carry the market back to 1360 and perhaps as far as the low 1400’s before resuming the move down which will likely get to around 1150 which represents just a little more than half of the move up from the October 2002 low to the October 2007 high, a bull move of 5 years.

I should hasten to add here what it appears I have not sufficiently expressed in these pages to this point as I read through them.  The problem we are facing is a credit contraction of elephantine proportions.  The equities bubble in 2000 was transformed into a real estate bubble over the next several years with nominal overnight rates of 1% meaning negative real overnight rates persisting for a considerable period of time.   Coupled with a surge of innovation in financial engineering and a relatively lax regulatory environment, the result was an unsustainable rise in real estate prices founded upon an unrealistic ability to pay for said real estate that was winked at at the time, or assumed incorrectly to be unimportant because the trend was from the lower left to the upper right.  But trends do not go on forever and the time has come to pay the piper.  As credit contracts because banks and others are not sure which counterparties are going to remain solvent, economic activity must also be affected negatively.  So the E in P/E gets revised downward.  So P/E can either rise significantly or P can fall.  So far it looks like the latter.  As the crisis in credit engenders a crisis in confidence, behavior becomes more penurious, which just makes the situation worse.  This is not the same problem that occurred in 2000-2002.  It is much worse.  And there are fewer levers to pull on the part of policy makers.  We cannot start another war for instance.  This type of problem takes some time to work out.  Like a year or more.  We are still early in the process.  Expect stocks to give up at least 50% of the gains from the October 2002 low to the October 2007 high.  It could be more.

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