Stocks Down Again — It’s An Official Correction
Kurt Brouwer January 21st, 2008
The weakness seen in the stock market at year-end has continued so far this year with concerns over financial issues, the subprime lending mess and a potential recession contributing to the negative environment. At this point, we are in what has historically been considered a stock market correction, which is a drop of 10-20%. From the most recent high point (October 9, 2007), the S&P 500 had fallen approximately 15% through January 18. So, now it is official. We are in a stock market correction, which is usually defined as a decline of 15-20% for stocks.
This is the first such correction in five years. Downturns are never much fun, but in my opinion, they are a necessary and normal aspect of stock market activity much as the occasional recession is a normal part of economic activity. They usually occur more often so this one is a bit daunting to people who have had a steady five-year run of positive markets. Here is an interesting story about a bullish analyst at Citigroup of all places [emphasis added]:
Burned But Bullish At Citigroup (New York Times, January 20, 2008, Nelson D. Schwartz)
IF any Wall Street seer should be bearish right now, it’s Tobias Levkovich, the chief United States equity strategist at Citigroup.
After all, last week his employer announced a whopping $10 billion loss, not to mention a 41 percent dividend cut and 4,000 additional job cuts. Shares of Citigroup and other financial giants are down sharply in recent months, a fact hardly lost on Mr. Levkovich, who has worked for the bank and its predecessor companies for 20 years.
“The hit my portfolio has taken has become a significant loss by anyone’s measure,” he says. “I feel crummy.”
Nevertheless, from his perch at the beleaguered global financial giant, Mr. Levkovich has the distinction of being among the most prominent bulls on Wall Street. His forecast calls for the Standard & Poor’s 500-stock index to reach 1,675 by the end of 2008, 350 points and 26 percent higher than where it closed Friday…
When it comes to predicting a 26% gain for stocks, Mr. Levkovich is probably in a party of one right now. Nonetheless, at some point the gloom will lift. What he is pointing out is that the sharp drop in stocks is indicative of a very steep decline in economic activity and corporate earnings. If the economy does not sink into a recession and corporate earnings do not crater, then stocks are oversold. He is in a minority right now, but it does appear as if the gloom and doom has been overdone, particularly in the financial stocks.
…With the S.& P. 500 dropping 5.4 percent last week alone, he acknowledges that his target “is clearly a number that is under duress; the idea that the market will be up 300 points from its current level is something I’m pretty sure people will scoff at.”
But, he says, “I’m sticking with it for now because I don’t have an analytical basis for changing that view.”
Crunching the numbers from past downturns while analyzing current earnings projections, Mr. Levkovich argues that the market has already priced in a 40 percent drop in earnings. That is far steeper than even the 20 percent profit drop that typically occurs in a recession…
…Mr. Levkovich says: “If you track long-term patterns of earnings multiples versus bond yields and equity-risk premiums, we’re at a level today that’s only occurred in 87 months out of the last 46 years. In every single instance the market was up 12 months later, with an average gain of 23 percent.”…
…“Investors have a tendency to chase performance,” he notes. “People put the most money into the market when it was peaking in 2000. Conversely, they tended to bail out in 2002, just as the market was preparing to rebound. So negative sentiment is actually a bullish sign.”…
He is correct that investors often get too optimistic when things are going well and too pessimistic when things are going badly. And, it is also true that investing after a large market decline is generally a good thing to do. However, that does not mean stocks have reached the bottom. Sometimes, stocks are cheap, but then they get much cheaper. If you are going to adopt this strategy, you must be a patient, long-term investor.
Hat Tip: Steve Janachowski
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