The Bullish Case: It’s Blood On The Streets!

``Many momentous historical developments occur without the participants fully realizing what is happening.” George Soros

It’s been reported that losses in Wall Street has hit $2.4 trillion this week and $8.4 trillion for the year (Forbes) while the Phisix lost some P 554 billion or about or about $11 billion over the week (inquirer.net). On percentage basis, the Phisix lost almost the same as Wall Street down by over 18% and is down 45% year to date against the US bellwether Dow Jones Industrials at 39% and S & P 500 at 42%.

As we have pointed last week, the US seems fast catching up on the Phisix on an apparent race to the bottom. But the optimistic angle for the Phisix, which used to be high beta or “high risk-high return” seem to have transformed into “low beta”. In short, US markets appear to be underperforming the Phisix on the downside as well as the upside.

Yes admittedly the overwhelming power of the global bears eventually did catch up with my “divergence” view from which the Phisix struggled to maintain but eventually succumbed. But nonetheless, if such outperformance manages to hold then come the time when the global markets begin to stabilize or consolidate we should see a faster recovery for the Philippine benchmark.

True, the technical breach from support levels signals the return of the bear market, but it is unclear if we could go deeper.

The optimistic case:

Figure1 BBC: Market Crashes Through The Ages

In Figure 1 from BBC which we have shown in August 2007 and August 2008 highlights the worst performance of the Dow Jones Industrials in terms of one day falls and worst bear markets relative to the scale of losses.

Since each crisis has its own tale, this week’s drop 18.2% is one for the history books (marketwatch.com). Nonetheless, the 7.3% drop last Thursday will be as included as part of the largest one day loss and where the weekly loss looks like the extended variant (instead of one day, it became a one week) of Black Monday Crash of October 19^th 1987.

But from the technical, sentiment, valuation point of view these events are starting to look better.

One, the Dow Jones Industrial’s historical bear markets suggest that the biggest loss EXCLUDING the GREAT Depression has been around 40-50% (right pane) which means unless you believe that the US is faced with the prospects of a great depression, this record loss could herald a near, if not an interim, or even a major bottom.

The Dow Jones Industrials has already exceeded the degree of losses incurred from its 2000-2002 bear market (36%).

Figure 2: stockcharts.com: Fear Index and Capitulation Signals

Next, technical indicators point to severely oversold conditions to the point of ‘capitulation’ (see figure 2) or as per investopedia.com, ``capitulation is associated with "giving up" any previous gains in stock price as investors sell equities in an effort to get out of the market and into less risky investments. True capitulation involves extremely high volume and sharp declines. It usually is indicated by panic selling.” (highlight mine)

Meanwhile the Fear index (topmost pane), as measured by the VIX is at confounding record highs. In previous occasions, the normal highs recorded were at over 30s (red vertical lines) which coincided with interim bottoms. This extraordinary fear is worth taking note of. Likewise the oversold conditions seem to be corroborated by the Relative Strength Index (RSI), seen at bottom pane, which is at below 30.

Figure 3: US Global Investors: Valuations Halved!

Nevertheless market actions appear to be pricing in a significant slowdown in global economies, according to Frank Holmes of US Global Investors (highlight mine), ``Trailing price-earnings ratios for global equities have been slashed in half since last year, as seen in the chart below. This is true regardless of whether financials are included in the calculation. In October 2007, the Factset Work Equity Index (10) generated a trailing P/E ratio of 18; that has now fallen to nine times earnings.

``Barclays made another important observation: The de-rating has been in response to the deteriorating economic climate. Basically, there’s been a traffic jam of inflation and credit shocks that has generated a global financial panic.”

So from the above perspective, we remember the famous contrarian advise of Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family, who reaped a fortune from the ensuing panic during the Napoleon’s Battle of Waterloo as saying ``Buy when there's blood in the streets, even if the blood is your own!” (investopedia.com)