EVIDENCE FROM A WHOLE HOST OF INDICATORS SUGGESTS THAT EQUITY MARKETS HAVE HIT BOTTOM AS A FULL BLOWN RECESSION BECAME FACTORED INTO CURRENT PRICES. STILL WAITING FOR SIGNS THAT A NEW DYNAMIC UPTREND HAS BEGUN, BUT IT IS TIME TO BUY

The trend of US equity markets turned into an elevator shaft as 2008 began. By mid-January, the TSX and other global markets could no longer hold their own and succumbed to the selling pressure. The reason for this sharp sell-off was a change in the sentiment of investors – they reacted to statistics indicating that we might enter a recession (two quarters of declining growth). The market decline reached a climax last Monday when many global markets fell approximately 5%. (Perhaps it was exacerbated when Societe Generale was forced to unload what could be over $50 billion worth of stocks bought by a rogue trader.) This finally prompted Ben Bernanke to discard his peashooter and bring out the canon by announcing a .75% cut in interest rates in between normally scheduled meetings. This was the biggest cut since 1984. The markets recovered on Tuesday and staged a stunning reversal on Wednesday, enabling the TSX to close the week with a gain of 1.24% while the SP 500 gained .41%. This should not have surprised the readers of this update.

Research from a prominent Canadian strategist shows that equity markets typically decline 17% from the peak during a recession. At the lows last week the markets were down almost 20%. In a normal recession, earnings decline an average of 14%, which would reduce the PE multiple of stocks down to 14.2 times earnings for the SP 500. Last week the SP 500 Index was trading at 12.2x forward earnings. This all implies that investors have priced in a full-blown recession for stocks. Even though a recession seems to have been ‘baked into the cake’, no one knows whether or not we will indeed experience such a slowdown.

I attended a talk by Alan Greenspan in Vancouver on Jan. 24, who is probably the best person to shed some light on future prospects. He believes there is a 50/50 chance that the US economy will enter a recession. He also stated that he thought that the US would enter a recession after the 1987 Crash and the terror attacks of Sept. 11, 2001. The US economy surprised him by defying historical precedents and avoiding a recession after both of those events. His conclusion was that the strength of the US economy should not be under estimated - it is very resilient.

Whether we enter a recession or not, almost every technical tool such as the TRIN, Volatility Index, Insider Selling, the extent of media coverage and the oscillators I use suggest that the selling last week reached an extreme level typically seen at a major market bottoms such as 1987, 1990, 1998 and 2002. Remember, once fear reaches an extreme and everyone that wants to sell has sold, the markets rise. Investors have therefore likely seen the worst of the selling. When the indicators show more signs of heavy buying and reduced selling pressure, we can declare that a new dynamic uptrend that could last for the rest of the year is in place. The long-term oscillators have turned up for the US financial and banking sectors, which usually lead the markets. However, the oscillators for the market averages have not quite turned up yet, but, like I said last week, that could happen at anytime. Bernanke might still bring out a bazooka at the Fed meeting Jan. 30. While our natural reaction to sudden market declines like this is to focus on the risk, it is after times like this that the gains tend to be the greatest – especially after the Fed has been reducing rates for some time. Although it may take some time for the markets to get going, this is the time to buy. Hang on for the ride!

Bonds, Commodities and Currencies – As forecast in last week’s letter, the trend for other assets reversed as the downtrend in equity prices reversed. Please see charts and comments for bonds, commodities and currencies below.

After giving a rare false signal in December, the long-term oscillators for the US Financial Services Index and Banking Index have turned up from very oversold levels. This should lead the markets higher as they did when these oscillators turned up on Aug. 20.

The reversal has not been enough to enable the long-term oscillators for the market averages to turn up. They turned up on Aug. 27, 2007 one week after the financials did an a 10 days after the Aug. 16 lows so perhaps it will take another week this time too.

The TSX has reversed and seems poised to rise at anytime after giving a rare false signal in December. It turned up 10 days after the Aug. 16 low as well.

Bond prices are likely peaking, as they should if equities have bottomed. The oscillator looks like it is ready to roll over.

Gold has been very strong and may be overbought after a big six-month rise. Gold stocks could out perform bullion now.

Oil prices have stabilized but the oscillator is still declining. More time is required to clarify if oil prices will increase from here.

The US$ likely peaked last week along with investor fear as the money which gravitated to the US$ for a safe haven flows out. The CAD$ likely experienced a multi-month low last week and is ready to rise.

According to this chart, the Euro has also bottomed and started a new uptrend.

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