Still No Bottom

It's been a while since I've posted. I was traveling last week with my lovely wife, driving around the Midwest with stops in St. Charles, MO (quaint), Louisville (for meetings), Memphis (for blues, a tour of the Gibson guitar factory and good, unhealthy Southern food), Springdale, AR (for some great fried chicken at AQ Chicken House, also quite unhealthy), and winding up in Pittsburg, KS to watch my beloved Gorillas smack down the University of Nebraska-Omaha for the second time this season, this time in a first-round NCAA Division II playoff game.

UNO's mascot is the Mavericks. It's been a tough year for Mavericks.

Okay, on to the topic at hand. I've been meaning to do some serious Paulson-bashing, but I'll try and get to that this weekend. The past two days in the market, while wildly profitable for contrarians like me, have been stunning enough that I need to take pause and address the question that Bubblevision asks every day:

Are we at the bottom?

Short answer: nope.

Yes, yesterday we breached the 2002 low on the S&P, which is now roughly half its level when I first predicted back in '01 that it would trade sideways for a decade or so. And we came close to the '02 low on the NASDAQ. But we ain't there yet.

A few simple answers to the question, "why?"

First, I saw a video interview with a technical analyst yesterday, and he was asked what he thought of the notion that stocks are cheap and we all should be buying. (Remember how the Oracle from Omaha told us all to buy stocks back in October? Brilliant dude, that Mr. Buffett. You'd have been better off taking your investment advice from Jimmy Buffett than Warren.) Anyway, the techie gave a very simple but sage answer:

"If stocks are cheap, why are they going down?"

Indeed. If stocks are cheap, there should be more buyers than sellers, which is the classic trader's answer to the question, "Why are we rallying?" Prices are going down, meaning there are more sellers than buyers. If stocks were cheap at these levels, the converse would be true.

Second, there are some fundamental things that I doubt anybody but me looks at, that tell me there's pain and suffering ahead that has not been priced into the market. To wit:

1. The NAHB Housing Market Index fell to a fresh all-time low of 9 this month. To put that in perspective, it was at 20 in April, above 30 a year before that, above 50 a year before that, and above 70 in mid-2005. And, as I've noted before, it correlates very well with the S&P 500, lagged about 18 months. Well, a year and a half ago, it augured for a low on the S&P of 600-ish. Before this month's new record low, it foretold a bottom in the S&P about 18 months out, at even less than that. And now, it's lower still.

I'm not using that as the basis for an argument that the S&P will fall to, oh, say 200. But it will certainly fall further. You have to dance with the one that brung ya, and housing brought us to this dance. The worst is not over yet for housing, so the worst is not over yet for the broader economy and the stock market. And the bottom for stocks could be a year or more away, though I'll probably turn cautious in about six months or so. Probably.

2. On a similar note, housing starts in October were the lowest ever. Let me repeat that: we started construction on fewer new homes in October than we ever have. Oh, okay, technically it's only since the data was first recorded - in 1959. A few scant months before I first graced this planet with my presence. But still - consider population growth since then. Yeah, you can go back further in time and find a date when we were building fewer homes. But they might just have been made out of lodgepoles and buffalo hides. Like I said, the worst is not over for housing, and as housing goes, so goes the economy.

(Oh, building permit issuance hit a record low, too, and they lead housing starts. So don't look for any improvement in starts soon, lest you think they're at a bottom too.)

3. Not only did the Empire Manufacturing Index - a survey-based index of manufacturers in the New York Fed region - fall to a new low in November, some of its components tell stories that are not yet priced into the market, but will affect it when the birds come home to roost.

a. Prices paid fell from an index level of 31.71 to 20.48. That's welcome news, as it means manufacturers' costs went down. Given that the component was as high as 77.89 in July, when oil prices peaked, that's a real positive.

However, prices received collapsed, falling from 20.73 to just 6.02. They had been generally tracking well with prices paid, but the sharp drop shows that, with the consumer in hibernation, companies have very suddenly lost all pricing power. They can't get financing, and now they can't sell product without just slashing prices. That will crush profits, beyond what current earnings expectations have factored in.

b. The number of employees component fell from -3.66 to -28.92, in a single month. And the average workweek fell from -9.76 to -25.30 (zero is neutral for these numbers, so negative readings signal contraction). This tells us two things. First, factories in the region cut payrolls sharply in November. We have yet to see the actual payroll numbers for the overall economy for the month, but they're likely to be shocking, below what's priced in. And second, for workers that remain, factories have slashed overtime. That's usually the last thing to go. And it means that those workers' purchasing power is eroding sharply.

Then there were a couple of things that seemingly might be priced into the market, but really aren't yet.

First is Citigroup's announcement that it will lay off 53,000 workers. Yeah, Citi's stock tanked, and dragged the markets with it, though the decline was broad-based. But Citi may yet fail or have to be sold or rescued. And, we have yet to price in the effect of those massive job cuts on spending, which has already fallen out of bed. Indeed, if the forecast for next week's personal spending release comes to realization, we'll see the weakest year-over-year pace of spending growth - barring the post-9/11 anomaly - since 1961. Weaker spending is expected, but not that weak.

Second, the possible bankruptcy of the automakers is not yet fully reflected, I don't think. Again, the impact on spending will be devastating, though I believe that allowing them to file Chapter 11 is still preferable to a bailout.

To digress briefly, let me explain why. The Detroit Three want $25 billion. The likely split is about $11 billion for GM and about $7 billion each for Chrysler and Ford. That's about two quarters' worth of cash at the current burn rate. So they'll either fail next year anyway, or need more cash. Lawmakers seem to be getting that, hence their reluctance to add more to the bulging bailout debt burden.

Back to the broader issue. Goldman Sachs released a report today forecast a whopping 5% decline in GDP growth this quarter, and unemployment hitting 9% at the end of 2009, and rising further into 2010. That is not priced into the markets. Even the Chicago Fed Bank President warned today that this recession will probably last through all of next year, when most earlier estimates called for weakness to subside around mid-year. Again, current equity valuations factor in those earlier estimates, not the new reality. (Well, it's not a new reality to me, but it is to Goldman and the Chicago Fed chief.) And a University of Michigan survey found that consumers expect the jobless rate to exceed 8.5% next year, so they apparently concur with Goldman.

Some of those consumers buy equities, at least through mutual funds. So, back to the techie's point - more sellers than buyers means stocks aren't cheap, and prices will fall further.

The simple fact that, after a massive two-day rout, we couldn't produce the usual euphoric dead-cat bounce today, is evidence that the tone is finally going full-bore bearish. So the bottom is yet to come.