Ugly describes the stock market last week. The Dow and S&P were down approximately 4% and the NASDAQ was down 6.5%. The Dow and S&P are approaching their lows for the year, reached during the August credit crisis. It’s hard to believe that just a month ago the Dow and S&P were at record highs and the NASDAQ was at its highest level since 2000. Market sentiment is decidedly negative or, to reuse my opening word, it’s just plain ugly out there. It wouldn’t surprise anyone if the market hit a new low for the year this week.
October High August Low Nov. 9 Close
Dow 14,164 12,861 13,043
S&P 1,562 1,406 1,454
NASDAQ 2,859 2,451 2,628
What’s happened over the last 30 days to turn the market around? More bad news came out of the financial industry with Morgan Stanley and Wachovia reporting big write-downs. Worry over the financial institutions has morphed from subprime mortgages to securitized mortgage pools, to collateralized debt obligations (CDOs), to structured investment vehicles (SIVs), and, most recently, to credit default swaps and the insurers of all these derivative instruments. None of this is surprising, or new, news and we have to keep the derivatives issue in perspective. Banks are sound, the problem is contained to the financial industry, and it’s not the first time the banking industry has experienced problems, i.e., the Mexican and Russian debt crises, Long Term Capital Management. Oil is trying its best to hit $100 a barrel, with dire consequences for home heating bills if we experience a severe winter, and the dollar continues to hit new lows (one of the reasons why oil prices continue to rise). The homebuilding industry struggles persist. It was sad to see the pioneer homebuilder, Levitt, file for bankruptcy protection this week. Lastly, retail sales were mixed and retailers are forecasting a poor Christmas season. What puzzles me, though, is that all of the above is old news. It’s been around for months.
The market ignored much good news last week. Exports continued to drive our economy (and are helped by the weak dollar), productivity growth was a remarkably strong 4.9% for the third quarter, wage increases were modest (both suggesting inflation is not a worry) and Mr. Bernanke spoke about continued economic growth (albeit weak in the near term) through 2008.
So why was the stock market at record highs last month and testing its lows for the year this month? Psychology. The glass has gone from being half full to half empty. Which view is right? October’s or November’s? Obviously, only time will tell. We’ll get an important piece of data, though, this week when the CPI is released. That will tell us the impact high energy prices and a weak dollar are having on inflation. My forecast is the CPI, particularly ex-energy, will come in better than expected. And, although, the market may go lower, the issues it’s concerned about have been around long enough for the consumer and business to adjust to them. I stick by my forecast that the market will show a 20% return over the next six to nine months.
