Wednesday Market update

Stocks recovered a portion of yesterday’s losses but weakened in the last hour of trade ahead of the start of a new quarter.

I still think the market is subject to discounting for the balance of this week as investors think twice about Friday’s jobs report and another poor earnings season but it was interesting to see what was being accumulated on the last day of the quarter.

It is now official. The US Financial Accounting Standards Board (FASB) changed the mark-to-market rules last week, effective immediately, or just in time to paint first quarter earnings in the banking sector.

This suggests that it is likely that some bank stocks will report better-than-expected earnings as banks write up the value of some of their troubled assets.

Whether the rest of the stock market will follow the financial sector based on this accounting change is the real question. It still doesn’t change the fact that most corporations are suffering through the worst earnings collapse since they have been keeping records on the S&P 500.

HOME PRICES CONTINUE TO FALL

I know we have seen a number of hopeful signs that perhaps we are getting close to a bottom in housing.

While sales of new and previously owned homes rose in February, essentially it was people buying distressed homes. The problem remains that home prices across the country continue to sink.

It was announced today that existing-house prices continued to decelerate. The S&P/Case-Schiller 20-city house price index declined 19% from a year ago, a greater rate of decrease than the consensus expectation, which looked for an 18.6% drop.

The 10-city index fell 19.4% over the year. Both indices again posted record rates of decline reflected broadly among metro areas.

Foreclosures surged 29.9 percent in February from a year earlier after rising 17.8 percent in January, according to RealtyTrac Inc. An estimated one in every 440 homes is in some stage of foreclosure.

“ There is still a lot of downward momentum,” said Michelle Meyer, an economist at Barclays Capital Inc. in New York. “We don’t think we’ll see a bottom in home prices until the second half of next year. The decline in home prices will continue to depress household balance sheets.”

We are not out of the woods in this sector.

If housing prices weren’t enough of an issue, credit card defaults are skyrocketing.

U.S. credit card defaults rose in February to their highest level in at least 20 years, with losses particularly severe at American Express and Citigroup. For example, Citigroup default rate soared 9.33 percent in February and 6.95 percent in January.

This barrage of troubles for the banking industry is one thing but the underlying crisis is still related to deleveraging and solvency. This is deadly combination for corporate earnings.

BEAR MARKET RALLIES

In the last three weeks we have heard from a lot of bottom callers who are now declaring the March lows as the beginning of a new bull market.

The 21.6% pop in the S&P 500 index has been impressive in March but if there is one thing we need to understand about bear markets is short covering squeezes are dynamic, impressive affairs but short lived.

In the bear market of 2000-2002 we saw three bear market rallies (19%, 21.4% and 20.7%) before an ultimate bottom was reached.

The current bear market has produced four double-digit bear market rallies (12%, 18.5%, 24.6% and the recent 21.6%).

In the Great Depression from 1929-1932 there was a total of five 20%-plus bear market rallies over the 34-month decline of 89.2%. The last rally produced a gain of 24.6%, but was followed by a final decline of 53.6%.

If a bottom was made in March, we won’t know if it was the actual bottom until the next intermediate-term bottom. What we need to see is a higher intermediate-term bottom from the last intermediate-term bottom.

FOUR BAD MARKETS

Recently, I came across a very interesting chart from www.dshort.com that I would like to draw your attention towards that compares the four worst bear markets.

The Dow Crash of 9/3/1929 – 7/8/1932 (34.2 months), 1973 Oil Crisis of 1/11/1973 – 10/3/1974 (20.7 months), Tech Crash 3/24/2000 – 10/9/2002 (30.5 months) and our current bear market which began on 10/9/2007 to present (17.7 months so far).

There are several things I want to point out about this chart.
First, I want to point out that the current bear market was comparable to the 1973-1974 and the 2000-2002 bear markets in the first 10 months.

Its downward slope was similar, but starting in the 11 and 12 months, the current bear market began pluningd at a much faster pace.

We are now in the 17th month of this decline and comparable in terms of depth and losses to the 1929-1932 bear market. Both had lost about 50% at this point in their bear markets.

Given the degree of severity of this bear market, I think we have to be very careful about assuming the bear market is completed – until we see technical proof that the primary trend is changing. We’re not there yet people! Not even close.

Secondly, notice that the average of the bear markets of 1973-1974, 2000-2002 and the 1929-1932 duration was approximately 28 months. We are now in the 17th month, so in terms of the duration of this bear market, at least compared to other severe bear markets, we aren’t near a trough yet.

Lastly, if you observe in the 1973-1974 bear market, in the 21st and 22nd months, the technical pattern showed a bottom followed by a retest of the lows, but note that the stock market established a higher low.

This is what we am looking for, a higher low on the next intermediate-term bottom. We are now approaching an intermediate-term peak sometime in the month of April.

P/E RATIOS AT 200 – REALLY?

In an article by financial analyst John Mauldin he writes that the Standard and Poor’s P/E ratios are unreal:

“ Just for fun, when I was interviewing with the New York Times today, I went to the S&P web site and looked at the earnings for the S&P 500. It's ugly. The as-reported loss for the S&P 500 for the 4th quarter was $23.16 a share. This is the first reported quarterly loss in history. That almost wipes out the expected earnings for the next three quarters. For the trailing 12 months the P/E ratio, as of the end of the second quarter, is 199.97. Close enough to 200 for government work.

But it gets worse. The expected P/E ratio for the end of the third quarter is (drum roll, please) 258! However, taking the loss of the fourth quarter off the trailing returns allows us to get back to an estimated P/E of 23 by the end of 2009. The problem is that you have to believe the estimates, which I have shown are repeatedly being lowered each quarter, and which I expect to be lowered by at least another 25% in the coming months.

Now, much of that loss is coming from the financials, which showed staggering write-offs of $101 billion, $28 billion coming from (no surprise) AIG alone. Sales across the board are down almost 9%, with 290 companies reporting lower sales.

This quarter the estimated consensus GDP is somewhere between down 5% to down 7%. Last quarter we were down an annualized 6.3%. That would be two ugly quarters back to back. It is hard to believe earnings for nonfinancial companies are going to be all that much better.”

BE CAREFUL!