	Generational Dynamics
	Forecasting America's Destiny ... and the World's

\| HOME \| WEB LOG \| COUNTRY WIKI \| COMMENT \| FORUM \| DOWNLOADS \| ABOUT \|

Generational Dynamics Web Log for 1-Aug-2008
CNBC's Jim Cramer announces that the market has hit bottom.

Web Log - August, 2008

CNBC's Jim Cramer announces that the market has hit bottom.

Pushing toy stuffed bears through a meat slicer, the screaming, peripatetic CNBC anchor Jim Cramer declared that he "had unbelievable guts to call a bottom," and said:

"I am indeed sticking my neck out right here, right now, declaring emphatically that I believe the market will not revisit the panicked lows it hit on July 15. and I think anyone out there who’s waiting for that low to be breached is in for a big disappointment and [they’re] missing a great deal of upside.

Stop waiting, [and] buy the next dip because I think it might be the last big one."

If you have a few minutes, listen to it yourself:

The first thing to note is that the reasons he gives are all based on data for the last few days. That data could all change in the next few days. People like Cramer believe that "history always begins this morning," and that's why they always get things wrong.

The analysis by Oppenheimer's Meredith Whitney predicting imminent meltdown of over 25 financial institutions at least uses 6-12 months of data.

And the analyses that I've been posting on this web site since 2003 all use decades of data. That's why they always turn out right.

(See "List of major Generational Dynamics predictions" for more information about these predictions.)

But for Cramer, a couple of days is all you need.

Let's take a look at some of the reasons he gives for a bottom:

"One is that the negativity is so bad we might be at the point of total capitulation. The investors Intelligence Survey reported a 30% bull-50% bear ratio. Fifty percent bearish! Who’s left to sell? That kind of despair and disbelief has historically been a sign, Cramer said, that the darkest part of night was ending and dawn was near."
Do you get this? People he's talked to don't believe him. Therefore, he must be right.

"Then there were the power moves yesterday by Merrill Lynch , whose newly issued stock is up more than 10% from its offering price. Merrill showed the rest of the banks that they, too, can unload all that bad paper, the CDOs, and cut a deal with the bond issuers to repair a much-damaged, and very important, business relationship. Now Lehman Brothers Lehman Brothers Holdings Inc , Citigroup Citigroup Inc and Wachovia Wachovia Corp can follow suit."
In other words, every other bank can just follow Merrill's example. Merrill is all right, since its stock went up for one day(!!), and so every other bank would be OK.
Is there anyone except Cramer who doesn't see the flaw in this reasoning? Even assuming that what Merrill did really worked, the reason it worked is because they were the first. As other banks join the fray, we can expect to see panicked selling, so the other banks will get far less than 22% of the nominal value of their assets.

"Also, plenty of companies have proved through recent earnings reports that they’ve been able to handle the commodity inflation that plagued the market for so long. How’d they do it? Price increases. And now that raw costs have come down, Cramer’s expecting a load of upside surprises because those price increases will stay put. (Cramer said the decline in gold just serves to verify the commodities crash.)"
Cramer is assuming that since the price of oil came down for a few days, that the price of oil will continue to fall! He assumes that oil will come down to below $110 per barrel, and he calls that a "commodities crash." Others are predicting that oil will spike to $200 per barrel. We'll see.

"The last piece of the puzzle is the housing bailout President Bush signed into law this morning. Bank of America , Wells Fargo Wells Fargo & Co and all the other major banks can now sell their bad mortgages to the Federal Housing Authority for 80 cents on the dollar. And despite what you think, that’s actually a mark up, not a mark down, compared to what they’d be worth if the FHA didn’t step in."
I don't know the details of this housing bill, but I do know that there are trillions of dollars of "bad mortgages," and the number is growing all the time as housing prices fall further. We'll have to see how this one works out.

"Cramer’s predicting the rally continues Thursday thanks to great after-the-bell earnings from The Walt Disney Co. and First Solar First Solar Inc . And who knows what could happen after Mastercard reports in the morning. “My bottom call isn’t gutsy,” Cramer said. “I think it’s just a smart call that all the evidence points toward.” “Bye, bye bear market,” he said. “Say hello to the bull and don’t let the door hit you on the way out.”"

Market summary, July 29-31, 2008

Market summary, July 29-31, 2008

Well, the last prediction is already wrong, as the market indexes were sharply lower on Thursday.

So we can assume that Cramer's whole "call bottom" thing is a colorful publicity stunt, with no rational justification whatsoever. If you've been depending on Cramer to provide investment advice, you might be better off flipping a coin.

Why there won't be a rally

Every few weeks, I post the reasons why a stock market rally is almost impossible, and today is a good day to do so again. This is the same argument that I've been using since 2003; only the data has been updated, and the details have changed. Regular readers may wish to switch to another blog.

First, and most important, corporate earnings keep falling. During the bubble they were way above the historic average, and now the Law of Mean Reversion is kicking in, and they'll be way below average for a long time.

Every week or two I post the table of S&P 500 average corporate earnings growth estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters.

Here's the latest table for second quarter earnings:

  Date    2Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%   Start of quarter
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%   End of quarter
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%
  Jul 18:             -17.1%
  Jul 25:             -17.9%
  Jul 28:             -17.8%  Mon
  Jul 29:             -17.9%  Tue
  Jul 30:             -17.9%  Wed
  Jul 31:             -18.0%  Thu

If earnings fall, then either stock prices have to fall, or price/earnings ratios have to rise.

As usual, a fall in earnings estimates means an increase of price/earnings ratios estimates. Here's the last Friday's version of the graphic that appears on the bottom of the home page of this web site:

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 25-July-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 25-July-2008. (Source: MarketGauge ® by DataView, LLC)

Price/earnings ratios have been astronomically high since 1995, and by the Law of Mean Reversion, they'll have to be far below average (well below 10) for an equivalent amount of time.

As you can see from the steadiness of P/E ratios (also called "valuations") since 2005, investors followed a formulaic strategy that kept the ratio at 18 for over two years. In March, P/E ratios jumped to a stratospheric level of around 22-23, and in the last month, the index has fallen to 21.

Putting these earnings and P/E figures together, in order for a rally to occur, investors would have to be willing to push valuations back up to 23 or 24.

Now, I'll admit that I was surprised when they went up to 23 after the March crisis, but it's hard for me to believe that investors are going to do that again. But this is the crux of the argument, and if you believe that institutional investors will do that, then you should expect a rally, and you should follow Jim Cramer's advice and buy, buy, buy. But I don't think that will happen.

In fact, I think it's more likely that P/E ratios will fall again to 18, which means that stock prices will fall at least another 10-15% for where they are today.

And if Oppenheimer analyst Meredith Whitney's prediction that 25 financial institutions will melt down in the next two months, the plunge could go a lot deeper.

As I've been saying hundreds of times since 2002, the stock market is overpriced by a factor of more than 200%, as I described in "How to compute the 'real value' of the stock market," indicating that we're entering a new 1930s style Great Depression. In 2002 I had no idea what scenario we would follow to reach that point, but the end result has always been certain with 100% probability.

Here's the first graph that I used in that article:

S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007

S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007

The historic average of the P/E1 (price divided by one-year trailing earnings) is about 14. From 1995 to the present, it's averaged around 25, creating a huge bubble. By the Law of Mean Reversion, the price/earnings ratio will fall well below 10 for a dozen years or so. You can see that it's poised to fall quickly in the near future, leading to a stock market crash.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (1-Aug-2008) Permanent Link
Receive daily World View columns by e-mail
Donate to Generational Dynamics via PayPal

Web Log Pages

Current Web Log

Generational Dynamics Web Log for 1-Aug-2008 CNBC's Jim Cramer announces that the market has hit bottom.

Why there won't be a rally

Web Log Pages

Generational Dynamics Web Log for 1-Aug-2008
CNBC's Jim Cramer announces that the market has hit bottom.