How bad is it and how bad can it get?
The current market downturn is approaching the end of five months and at this point, there aren’t many who think the worst is over. We have seen a couple of impressive single-day rallies over the past few weeks, but they have not been enough to reverse the downward trend. In spite of the Fed’s best efforts to keep the economy on track there might not be any way to reverse this slide because there are too many uncertainties right now.
When it comes to analyzing the current situation, the easiest way to make some comparisons is probably to review past corrections. Below is a chart showing the past 10 years of market activity and by any measure, it is apparent that this correction is significant. The black line is the price movement of the Dow and the gold line is the S&P 500. Over this period, the only two years that have produced larger corrections were 2001 and 2002. But this year and this correction are far from over.
One thing you’ll notice is that even in 2001 and 2002, sharp downward moves were usually followed fairly quickly by significant upward moves. We are not seeing a similar reaction today. The one- to three-day rallies we’ve seen recently have not been enough to undo the damage that is occurring on the down days. It would be nice to believe that the markets are overdue for some sort of recovery, but the bad news just keeps coming. This week it was $110 a barrel oil and the problems with Bear Stearns.
The bottom portion of the chart is a moving average convergence divergence (MACD) for the Dow. While it shows that the Dow is generally in an oversold state, that does not mean a turnaround is imminent. Before that happens there has to be some reason that investors would want to step back into the market and start buying. Right now, the best hope would likely be first-quarter earnings reports that start appearing in April. If investors see evidence that companies are continuing to profit in spite of spending cutbacks and higher prices, then we could see a market recovery. On the other hand, if the earnings reports are bleak, chances are the economy is in for a very long and very bad year.
So far the presidential candidates don’t seem to be focusing much attention on the economy. They keep getting distracted by the war, racism, sexism and religion. They might do well to reflect on the success of former President Bill Clinton’s first campaign where he beat incumbent President George Bush by reminding voters at every opportunity that the most pressing issue was the economy. The latest polls show that none of the remaining candidates enjoys a significant lead and none have a majority of support. My guess is that right now most Americans are far more concerned about the economy than any other issue. The candidate who can convince voters that he (or she) can quickly fix the economic mess would likely take the lead.
The markets are closed tomorrow for Good Friday and the Easter holiday. Have a great weekend and I hope you have some nice spring weather.
F.S.
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