Volume I, Issue 41

ALL INDICATIONS OF AN EQUITY LOW ARE IN PLACE BUT IT ISN'T OVER UNTIL IT IS OVER. THIS IS THE WEEK WHERE MOST MAJOR MARKET LOWS HAVE OCCURED IN RECENT HISTORY. THIS IS IN ESSENCE A CREDIT CRISIS, NOT A STOCK MARKET CRISIS. THE TED SPREAD IS THE INDICATOR TO WATCH. PRIVATE EQUITY IS STARTING TO BUY. IT IS NOT USUALLY A GOOD IDEA TO SELL A CONVERTIBLE IN A SNOWSTORM.

Stocks are very under valued, insider buying is high and there has been a panic selling. All the characteristics typically seen at a market low are present. While markets should bottom anytime, how much more damage is done before a turn around occurs is anybody's guess. The most recent crisis for the economy and the markets was the Sept. 11, 2001 terrorist attacks. The markets declined sharply for a week after North American equity market reopened. A recession was widely expected as the tragic loss of life resulted in consumers staying home, not knowing when another attack would strike. However, the equity markets bottomed after the selling was exhausted on Sept. 21 and rose by 22% by the end of the year and kept on advancing into 2002. History has shown that the American economy, consumer and equity markets are much more resilient than ever expected. The most memorable equity declines have occurred in 1929, 1974, 1987, and 2000 after stock prices rose too high and became very over valued. This is not the case this time. This is a debt crisis, which is affecting the economy and the equity markets. Therefore, debt markets will likely languish for some time, but equity markets could recover faster than they did after periods of overvaluation.

The TED spread is the difference between the interest rate on short-term US government debt and the interest rate that banks charge each other for loans. This chart only goes back to 1992. The TED spread went to all time record highs in recent weeks as it broke above the 2.7% level that was reached during the 1987 crash. A decline in the TED spread will be a clear sign that the credit situation is improving.

During the last 40 years, more significant market lows have occurred during the early days of October than any other time. For example, Oct. 3, 1974 (Nixon impeachment/spike in oil prices), Oct. 19, 1987 (stock market crash), Oct. 11, 1990 (Iraq invasion of Kuwait), Oct. 8, 1998 (Russian default/hedge fund collapse), Sept. 21, 2001 (terrorist attacks) and Oct. 11, 2002 (end of 2000 - 2002 bear market) are dates when severe declines of the US SP 500 Index have ended in the past. In most cases, a cut in US interest rates was the catalyst for the turn around. Perhaps history will repeat itself in the days ahead.

While there was very little control over what terrorists could do in 2001, politicians and regulators around the world can take, and are taking meaningful action to improve liquidity and confidence, which should ultimately be successful. One of the first signs that this is happening will be a decline in the TED spread as seen above. I believe that is the indicator to watch to signal a positive change.

Governments are spending tax payers' dollars to support troubled financial institutions, but the return of the corporate and private buying is required to get money flowing again. Warren Buffet has said, "Be fearful when other are greedy and be greedy when other are fearful." He recently put his money where his mouth is when his investment fund purchased a $5 billion of shares in Goldman Sachs and a $3 billion in General Electric. Last week, CIBC sold over $1 billion worth of subprime loans and Citicorp and Wells Fargo are both eager to buy troubled Wachovia Bank. At some point the money will rush in to take advantage of these bargain prices.

Pension funds and mutual funds usually invest between 45% and 65% of their assets in equities, but hedge funds can invest between 0% and 100% of funds in equities. Sources in New York have told me that some of these billion dollar hedge funds have sold most of their equities. With so much money in hedge funds now, perhaps that is why the markets seem to be more volatile than usual. When markets recover, these same hedge funds will have to participate, which could also drive up faster than normal. Only time will tell.

US market commentators have said that selling stocks now is like selling a house before a hurricane. Here, in Canada, I would compare it to selling a convertible in a snowstorm. A person will likely have to drop the price for a convertible substantially below what it would normally be worth, in order to sell it in a snowstorm. Waiting a few month until better weather arrives in spring would give the seller a much better chance to realize the full value of the convertible. The same principles can apply to stocks at this time. Hopefully signs of "spring" will emerge soon!

Bonds - US bond yields are not declining to new lows, as one would expect given the flight to quality. That is not very positive for bonds. Short-term cash is king.

Commodities - In spite of the greatest concern about the global financial system in a generation, on Friday the price of gold was almost $200 below the March $1,011 high. This is not positive for gold. US cash still seems to be the preferred asset when there is widespread fear. It is unlikely that oil and other commodities will not move higher until there are signs that liquidity in the financial system is improving.

Currencies - After being despised for years, the US dollar has regained its reputation as a safe haven. However, the oscillators suggest that the euro and CAD$ could quickly turn up along with any positive developments.

The long-term oscillator for the SP 500 is declining again after turning up from the fully oversold position in mid-July when the financials and US homebuilders hit lows that still stand to this day. A reversal to the upside is required to confirm a new up trend.

Believe it or not, most US and Canadian financial stocks are still much higher than they were in mid-July. This shows what happens when the selling is exhausted, even if there is still bad news. The same thing should happen to equities soon. The financials are correcting/consolidating after a sharp rise until this oscillator turns up again.

The fear indicator (Volatility Index) has reached the highest level since the 1987 crash when it peaked at 150! However, the oscillator is not as high as it was in July when the VIX only peaked at 31. This often signals a downturn. A decline in the VIX and the oscillator would be positive for equities.

This chart shows the steep decline of the TSX in the last 2 weeks. Surprisingly, the long-term oscillator is still on the verge of turning up. The selling in resource stocks is so heavy that Russia has halted trading in their markets for several days. Today Brazil temporarily halted trading in their markets twice for the first time since 1999 when their currency started trading freely. The uncertainty, fear, complete lack of confidence and panic selling seen around the world this morning are classic signs of a market low. Time will tell.

The oscillator is still rising for gold stocks. It is difficult for gold stocks to rise if the markets in general are declining.

Oil stocks gapped lower this morning as recession/depression fears mount. However, the oscillator is suggesting that oil stocks could rally as soon as confidence begins to return. Prices just about always rise to fill the gaps.

US bond prices have risen, but not any higher than they did late last year even though the financial concerns are much greater now. This is not positive for bonds. The oscillator could turn up again if bonds stay at these levels.

So far, the up trend for gold is intact, but the pattern of lower highs since March is worrisome. Gold performed better after the crash of 1987 as the situation stabilized than it did during the crash. Perhaps gold will move to the upside when confidence returns and investors look for places to invest cash.

Most asset and commodity prices are falling as investors flock to cash. Oil is no exception. However, the oscillator suggests that oil could have a good rebound when confidence returns. A depression was forecast after the 1987 crash and there have been forecasts of recessions after every serious market sell-off. Many of those forecasts turned out to be wrong. Today's dire forecasts could be wrong too.

The euro has fallen sharply after rising for almost 3 years. This is not unusual. I would not be surprised to see the euro, TSX and commodities begin to rise again and the US$ weaken after this corrective phase is over.