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Friday, 26 June 2009

Were the March Lows the Ultimate Market Bottom?

By Simon Maierhofer

As investors, we like to receive affirmation for our decisions. If you buy a certain stock or fund, it sure feels good to find out Warren Buffett did the same thing.

When it comes to owning stocks right now, there's certainly plenty of affirmation. Warren Buffett doubled down on his bet on America, the Fed sees the recession nearing a bottom, and Jeff Mortimer, CIO of Charles Schwab, says that the March lows are a text book bottom.

The ultimate judge however, is the market itself. The market does what the market wants to do, not what the Fed, Mr. Buffett, or anyone else thinks it should do (more about that later).

In an effort to find out where the market is headed, and whether the March lows will hold, we will examine the opinions of some of Wall Street's brightest minds and match those up against long-term indicators with a historic track record of accuracy.

Redemption for Warren Buffett

The 30% spike off the March lows must feel like redemption for Mr. Buffett. In his October 16th, 2008 New York Times co-ed interview, Mr. Buffett stated the following: 'I've been buying American stocks ... If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.'

Since Warren Buffett's October 2008 interview, the S&P 500 (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC) dropped another 30%, while the Financial Select Sector SPDRs (NYSEArca: XLF - News) fell as much as 62%. I wonder if Warren Buffett is already invested 100% in U.S. equities.

Contrary to Buffett's viewpoint, the ETF Profit Strategy Newslettr predicted a 2008 bottom below Dow (NYSEArca: DIA - News) 7,500, and a Q1/Q2 bottom below Dow 6,700 (the Dow bottomed at 7,392 and 6,440).

Regarding the March 2009 lows, George Soros, the billionaire investor who came out of retirement to steer his Quantum fund to an 8% gain in 2008, believes that the worst is over and the risk of a collapse has passed. Mr. Soros is convinced that the government's bank rescue plan will ultimately revive ailing financial institutions, such as represented by the SPDRs KBW Bank ETF (NYSEArca: KBE - News).

A less gloomy Dr. Doom

Nouriel Roubini, one of the few economists who foresaw the financial debacle, follows the same train of thought. In April, he said that, 'Policymakers in the US, Europe, China and abroad have decided to use at maximum all their policy instruments (monetary, fiscal, cleaning up banks, resolving debt problems, helping emerging markets), they are using the bazooka and mid-size rocket, and that policy stimulus eventually will slow down the rate of economical retraction. We are seeing improvements that will get us out of this global recession by the end of the year.'

Mr. Roubini, who previously earned the nickname Dr. Doom, thinks a retest of the March lows is likely but does not expect a serious breach of them.

Interestingly enough, the credit for the recent rally is given to the Obama administration for (successfully?) diverting financial disaster. In reality, the market had begun its rally nearly two weeks before Mr. Geithner announced the Public Private Investment Program (PPIP).

After a 55% decline, some sort of rally was surely overdue. As early as mid-November 2008, the ETF Profit Strategy Newsletter predicted that the 2008 lows would be broken, followed by a multi-month rally. Early in 2009, the target level for a bottom was narrowed down to Dow 6,700 - 6,000 range followed by a 30-40% rally.

Charles Schwab Execs are bullish

From a technical perspective, Jeff Mortimer, CIO at Charles Schwab, says that the March lows are a text book bottom. The market is still undervalued, 'buy the dips' over the next 12-18 months, Mortimer advises.

According to a May 7th interview with Paul Allan Davis, a managing director who manages $4.5 billion for Schwab, the fact that higher risk sectors such as the Consumer Discretionary Select Sector SPDRs (NYSEArca: XLY - News) and Technology Select Sector SPDRs (NYSEArca: XLK - News), along with small-and micro cap stocks, such as represented by the iShares Russell 2000 (NYSEArca: IWM - News) and iShares Russell Microcap (NYSEArca: IWC - News) are outperforming defensive areas, is a bullish sign.

Commenting on Mr. Davis' thoughts, a reader posted the following note: 'Isn't this guy two months too late. Many stocks have already doubled. Getting in now isn't gonna get you the big return. Roubini said L shaped recovery - he was wrong. I listened to the wrong people, I am dumb and mad.'

There is some truth to his words. The doomsday atmosphere reached new levels surrounding the March lows. Where was the financial leadership? How come all the brilliant minds didn't tell us to buy the March 9th lows? It's easy to make judgments months after the fact (we'll see if that judgment will be correct).

On March 2nd, the ETF Profit Strategy Newsletter sent a Trend Change Alert to subscribers on record advising them to start selling short ETFs, and accumulate long and leveraged long ETFs. Depending on your risk tolerance, those ETFs included plain vanilla index ETFs like the iShares S&P 500 (NYSEArca: SPY - News), and dividend ETFs with high exposure to financial, or leveraged financial, ETFs like the Ultra Financial ProShares (NYSEArca: UYG - News).

Also, after the fact, comes Gary Stern's assessment that the Economy is nearing the recession's bottom. Gary Stern is the President of the Federal Reserve Bank in Minneapolis and the longest serving Federal Reserve official. Mr. Stern sees increased consumer spending, partially caused by an uptick in lending activity. This is often the beginning of a new cycle of economic expansion, he points out.

Just a snapshot - not a forecast

You may have noticed that the forecasts by Messrs. Buffett, Soros, Roubini, Mortimer, and Davis are contingent upon successful government intervention, or current data. Data such as consumer spending, retail sales, housing starts, etc. is merely a snapshot of the current situation. As such, they have no 'crystal ball-like' powers.

To the contrary, as we've seen in March and late 2007, news in general tends to be good towards the top and bad towards the bottom. News-based forecasts are subject to change; and who likes adjusted forecasts?

How would you feel if your car dealer told you that it was necessary to 'adjust' your estimate because they didn't figure their cost correctly? 'Adjust' for investors always means losses to their portfolio.

Warren Buffett made a very insightful comment in September 2008, right before he decided to invest in Goldman Sachs. He said he 'believes the proposed federal bailout will get approved and succeed. He further states that if congress fails to approve the bailout, all bets are off and his investment in Goldman Sachs, along with all other investments, will get killed.'

As we know, the bailout did get approved. The initial success rate was close to zero. Mr. Buffett's net worth, along with the stock market, shrunk by some 30%. Is it really smart to base your decision on the success of an event that is completely out of your hands, and entirely unpredictable?

Forward looking analysis based on the market's own internal indicators, tends to be much more reliable than external, often unrelated, projections. Who would you trust to take your body temperature; a doctor sitting right next to you, or a nurse trying to take your temperature over the phone?

The market's internal indicators

Just like the human body, in its own language, the market conveys whether it's overheated, fairly valued, or undervalued. Ironically, most analysts choose to ignore the market's signs. Schwab's Mr. Mortimer, compared the March lows to the 1974 and 1982 market bottom. Despite a discrepancy in P/E ratios (compared to the '74 and '82 lows), Mr. Mortimer believes the market has bottomed.

An analysis of all historic market bottoms over the past 100 years shows that the stock market simply has not reached rock-bottom unless P/E ratios, and dividend yields, reach certain levels.

Just as ice does not melt until temperatures are above 32 degrees, the market does not bottom until those levels are reached. This timeless piece of Wall Street wisdom has protected many investors from financial ruin and will continue to do so.

Students of such faithful indicators can use the market's signals to identify a target range for the ultimate stock market bottom. This target range is not based on current snapshots and opinions; it's founded on historic patterns and what the market is saying. The March and June issue of the ETF Profit Strategy Newsletter contain a detailed analysis of P/E ratios, dividend yields, the Dow measured in gold (NYSEArca: GLD - News), and other trusted indicators, along with target ranges for the ultimate bottom.

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