S&P500 dropping to 600 by spring 07

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Submitted by powayseller on August 28, 2006 - 10:49am

"The chart halfway down in this link, originating from Merrill Lynch economist David Rosenberg (sent to us by a friend in Chicago), shows a surprisingly high correlation (lagged that is) between the US stock market and housing (NAHB housing index vs S&P 500 lagged 12 months; a 79% correlation)."

This chart predicts the S&P500 will keep falling and hit 600 by summer 07.

Of course, it only has a history of 10 years, but it's remarkably accurate.

This correlation makes sense, since housing leads the economy. Today, housing is the economy.

One more reason to stay out of the stock market for another year at least. Sorry, no fall rally for the mid-election year cycle folks.

Submitted by an on August 28, 2006 - 10:55am.

If you truly believe this, then wouldn't it be even better if you put your $ in the market and buy those bear funds that short the market?

Submitted by powayseller on August 28, 2006 - 11:56am.

I don't short, but I truly believe this, so I put my money where my mouth is: I liquidated all my index and mutual funds, and went 95% cash in March 06, because I did not want to lose my money. I've been convinced since early this year that the stock market would take a dive until this housing bust is over.

BTW, this NAHB chart is new to me. It's another piece of confirmation for exiting the stock market at this time.

I would really like to short a lot of different companies and indices, but don't know where to find a knowledgeable professional who can assist me. I am ready to do it with professional assistance, someone who has shorted successfully.

Schahrzad Berkland

Submitted by cabinboy on August 28, 2006 - 12:15pm.

That plot is a bit silly. The corrleation may exist from '96 on, but what did it look like in the last downturn? I suspect there won't be nearly the correlation. Also, just because the S&P is dipping, that does not mean there's no money to be made in the stock market.

Powayseller, I like your posts, but you may have reached the point where you're a bit too in love with the outcomes you're predicting. Your posts are packed with prediction upon prediction, each being less substantiated than the next. Most on this board agree that the the coming drops in RE prices will meet or exceed what happened in '89-'95. This prediction comes primarily from the facts that our deviation from historic price appreciation is greater this time than the last, and the affordablity index is even lower. All reasonable. Now, opinions on this board begin to diverge as we discuss the impact that this RE drop will have on the overall economy, and most important to the individual investor, the future prices of stocks and commodities. Your doom and gloom predictions for the economy and stock prices as a whole are very aggressive, and represent a minority position even among bears (Roubini aside).
If I take Lereah's advice and buy a home right now, I'm sure to realize a loss. If I get too influenced by your position, I'll be 95% in cash (foreign currency, of course), and I'll no doubt miss out on some nice gains (many mutual funds performed very well in 92-96, despite RE's troubles). Granted, a loss is more of a bitch than an unrealized gain, but both will affect one's living standard and retirement over time.
Be careful of falling into the same trap as the RE speculators. This board is highly populated with folks who sold RE in 2005, some by chance and some by foresight. Those that did are no more a financial genius than those that haven't sold (though they likely do have an edge on the small % of folks who recently bought). If your portfolio of cash is not significantly larger in 2010 than it is now in 2006, you'll have lost ground to a lot of moderates who are skilled at making money in a variety of markets outside of RE.

Submitted by powayseller on August 28, 2006 - 12:29pm.

Hi cabinboy, you wrote "(many mutual funds performed very well in 92-96, despite RE's troubles)." Your years are troubling me somewhat. How did the mutal funds do heading into the housing downturn? Examples, please.

The correlation with NAHB was plotted only to 1996, but it is very well known about the correlation between the housing market and the economy. Edward Leamer has a report which shows that housing leads the economy. Every time housing has turned, a recession followed.

Cabinboy, how can the stock market go up when corporate profits are falling? Leamer's report negates your story. Sorry...

Sometimes, economic cycles are such, that the best thing we can do is preserve our assets. This is such a time. This is the time to take your winnings off the table, hold in cash until we are in the middle of the recession next year, and then buy back at the bottom. When s&p is at 600, then get back in.

Do you want me to find you Leamer's report, or could you just google it? It's not his opinion, but a report showing how housing led the economy into every recession since WWII, with the exception of the years we propped up the economy with war spending (Korea and Vietnam). But this time, Leamer says, we don't have the financial strength as a country, to fund a big war.

Submitted by an on August 28, 2006 - 12:39pm.

I completely agree with you cabinboy. There are always money to be made in the market, even when the indexes are going down. Big money in the market never exit the market, they just move it from one sector to another, or take some of it out and put it on the sideline for a short while, but it'll be back in sooner or later. Just look at the last market crash in 2001, if your $ is in tech, you lost big, but if you take that $ and put it in oil, gold, RE, you'll gain big.

powerseller, last I check, corporate profit is still huge in the oil industry. Also, the telecom industry is finally starting to make a come back too. Large cap stock hasn't rally as much in this recent upswing to merit a major decline.

Submitted by FormerSanDiegan on August 28, 2006 - 12:39pm.

Investigate further.

S&P and HMI: Plot of S&P 500 and NAHB/WF HMI index.

Note the >50% drop in HMI in 1994, which preceded the huge run-up in S&P 500.

Like the "journalists" that spew real estate mis-information you need to look at the rest of the story and question the assumptions.

Note: I plotted the S&P 500 Close price adjusted for dividends and splits per Yahoo finance

Submitted by FormerSanDiegan on August 28, 2006 - 12:41pm.

During 1992-1996 S&P 500 posted about a 50% increase including dividends, so many index mutual funds must have faired well.

Submitted by powayseller on August 28, 2006 - 12:48pm.

Thanks for that chart, I was also wondering why they started in 1996.

But the fact is: every housing downturn since WWII has caused a recesion. Leamer's work. Check it out.

Yes, you can make money in the market when it goes sideways, but only if you are very lucky. How many of us bought gold in 2000? I was smart enough to load up on index funds in 1999, and did very well. But I didn't think about gold.

Chris J, a trader, can make money on small moves in the market, catching the rallies which occur even in a bear market. I don't know how to do that. So I stay away from bear markets.

asianautica, How will you make money in the stock market, when everything is falling? Commodities are a bubble too. Any risk you take on could be richly rewarded, or you could lose most, even all.

Recession will lower inflation and oil prices, so oil company profits will go down. Higher costs to extract from oil shale will eat into profits too. Zeal is what I follow for commodities, as it is their forte and I know little about it.

How many people clearly said in 1999, "This tech bubble won't last, so I'm loading up on gold, oil, and real estate". I doubt too many. iTulip's guy is the only one I know. Goldbugs have been goldbugs for years, so it wasn't a clear decision made to switch from stocks to gold. The point is: the next hot thing is not obvious. In a recession, all drops: oil, real estate, telecom, stocks. It all drops. Gold rises with inflation, so I don't expect gold to rise just because we are in a recession.

Well, if you can figure out how to make money in a falling stock market, I will put you on my list of people to call for financial advice when this is all over.

Submitted by an on August 28, 2006 - 12:49pm.

I was 19 in 1999 and just started investing. All of my portfolio was in tech. I made a killing until 2001. I was not aware of any other sector at the time, so I got killed with the .com crash. That was an expensive lesson I learned, also it's only several k, it was a lot for a 20 year old. I did more research after the crash and learned my lesson. Now, I keep an eye on all sectors. You don't have to do day trading to make money in a down market, you just have to know which sector to be in at any point in time. After all, I'm still learning and perfecting my skills as life give me more lesson.

Submitted by FormerSanDiegan on August 28, 2006 - 12:52pm.

PS -

I have no problem with the general assumption that housing downturns tend to lead recession.

My problem is in predicting a > 50% decline in the S&P 500, which I thought was the point of this thread.

Submitted by mrquoi on August 28, 2006 - 12:59pm.

You've checked on proshares short funds, right? SDS,SSO

If you are *certain* the S&P is going to drop then you are certain to make some nice money -- in the stockmarket.

Here's a funny thing. I know several people (liberal treehugger types) who decided to cash out of the market go into gold and euros when GWB was reelected in 2004. Though I don't agree with the reasoning, it was a smart move in retrospect.

Submitted by powayseller on August 28, 2006 - 1:18pm.

In the 2000-2001 recession, the S&P 500 lost the following in each of quarter of 2001: -23.2%, -39.4%, -35.4%, -24.2%.

In the 1969 - 1970 downturn, the quarterly losses from Q4 1969 - Q4 1970 were: -7.5%, -10.3%, -7.5%, -11.7%, -14.5%. Not as bad that time.

I don't have the data for the other recessions.

In any case, you two have to ask yourselves this: which stocks went up and earned more than CDs, without taking on any more risk, AT THE SAME TIME that the quarterly loss in the S&P500 was anywhere from 7.5 - 39.4%. That is a tall order. If you can pull that off, you can earn millions on Wall Street. Document your portfolio, and then show it to the traders when this is all over, so you can build your legacy. The odds are certainly against you.

I researched this spring which stocks to buy during a recession. The problem is everything is so darn overvalued right now. Storage places and pawn shops are two of the best recession proof industries, but at 25 x earnings, no way am I interested.

If we had a 35% decline in 2001, which was a very mild recession (and the 1969-70 was just a downturn not a recession), a 50% drop is very likely.

Now the ball is in your court to show how any stock can rise more than the risk-free yield on CDs, at a time when housing starts are falling over 25% year over year, which has led to a recession every time except when we were engaged in an expensive war. In the history of our markets, has this ever happened? Not to my knowledge.

What sector is going up? Where can you earn more than risk-free 5.5%? Anywhere? I have been posting about this since February at least, and I nobody has given any answers, other than shorting which I won't do. If someone has some ideas, I am all ears...

Schahrzad Berkland

Submitted by an on August 28, 2006 - 1:45pm.

I don't remember where I heard/read the following info, but usually, the stocks that are safe during recessionary period are stocks of company that sell things that people need, regardless of market condition. One example is WFMI, whole food supermarket. It rises throughout the 2000-2001 recession. Another is Johnson & Johnson, it rises a little bit in 2000-2001 and rise a lot between 1970-1973. Same with Merck. So you see, yes, the index goes in cycle just like everything else in the market. However, not everything sector in the market go in the same cycle. I don't have much data to prove my point for the 69-70 recession period, but I'm pretty sure there are sectors that went up during that recession, just like there are some in the 2000-2001 recession.

Submitted by powayseller on August 28, 2006 - 2:05pm.

an - lots of consumer companies did well during the 2000-01 recesion, bec. it was NOT a consumer recession, but a capital spending recession.

2000-2001 was a capital spending led recession, and the consumer kept on spending, so none of the consumer stocks went down, they just kept going up. That won't happen this time. I bet JJ is overvalued, so they will go down with everyone else.

In 2000-2001, all Asian exporter stocks went down, except China, bec. it was selling mainly textiles and people were buying clothes, but not business goods. Commodity went down too. Check out Richard Duncan's The Dollar Crisis.

an - you're a smart guy, so I love debating with you. But here's my problem - I am ready to start my own website, so I need to take a break from piggington to work on my own stuff.

Whole Foods is down now, I think. The others you mention - any have PEs below 12?

Submitted by rocketman on August 28, 2006 - 2:43pm.

I came across this article this morning I thought was interesting. It seems more investors are pulling out of small caps in lieu of large cap stocks for safety reasons Link to article .

I have been wondering why gold is not in as much demand I think it should be lately. One thought is that Global Bankers are selling as much gold as people out there are buying - trying to keep things from unraveling. I'm not sure how long they can last.

Another idea is that the dollar is still strong and so the psychology to buy is not there yet. Look what happened to the Yen today. It's hard to argue when you see the Yen fall against the dollar so sharply. However Chris J points out there is not much correlation between the dollar and gold.

I like the article PS. Thanks. One stock advisor I have been checking out lately is Gorilla Trading . I bought a monthly membership for $59.00 / $499.00 a month/year and the Gorilla advises on longs and shorts. I think I'd rather be using this service in a more Bull market - but he does advise on shorts as well.

If anyone has any feedback on The Gorilla I'd like to hear it.


Submitted by FormerSanDiegan on August 28, 2006 - 2:17pm.

PS - I agree that stocks suffer in recessions, that is not my point.

Your original post stated
This chart predicts the S&P500 will keep falling and hit 600 by summer 07.

I have a problem with interpeting this graph to mean that when the HMI decreases by xx% (currently 50%) the stock market declines by xx %. Making a quantitative argument for S&P 500 dropping to 600, based on the false premise that the HMI index predicts stock market values 12-months hence is dangerous.

Now as for predicting a recession and a significant decline in stocks based on weakness in housing. I can agree with that general statement.

Once again, it's the quantitative part that bothers me.

Good luck on your endeavor. Look forward to seeing the occasional thought provoking posts, even if they are more infrequent.

Submitted by Chris Johnston on August 28, 2006 - 5:53pm.

Chris Johnston

During the period of time that data covers there were only 2 mid-term congressional election periods, both of which produced a rally. In any event, a sample size of 2 is meaningless data chatter. You cannot draw any conclusions from a set up two. You could have two consecutive heads come up vs tails, which hardly means every flip of the coin will be a tail.

Small sample sizes on fundamentally based relationships is okay, but not that small.

Submitted by Chris Johnston on August 28, 2006 - 5:57pm.

Chris Johnston

Rocket man - the phenomena you mention about large caps is a bearish sign. I mentioned this in my post on May 10th in my blog as a reason to sell your stocks. When the Dow starts out performing the S&P 500 it is a reason to start looking for a sell spot.

The dollar does have an indirect relationship to Gold. The point of that section of my newsletter was just watching inflation keeps your analysis much simpler, and the straight correlation is better. KISS is very valuable in investing.

Submitted by rocketman on August 28, 2006 - 9:17pm.

Thanks for the clarification Chris. Your newsletter is very professional and informative. Yes, the dollar appears not to be the only factor. I will be keeping my eye on inflation. I think the article I was posting had to do with how investors are starting to head out of risk and into safe mode. If I am not mistaken, this looks like a gradual set-up for a new sector of investments (precious metals and gold). However, I see a lot of news from the metals sector advocating gold and they have to make a living too :-). So who are you going to believe nowadays?

I've never seen anything like these times for investing. It used to be KISS - now everything is too unpredictable and you got to pay major attention. Thanks again Chris.

Submitted by ybc on August 28, 2006 - 9:21pm.

Chris, can you give the address of your blog? THanks.

Submitted by Daniel on August 28, 2006 - 9:40pm.

Powayseller asked...

"which stocks went up and earned more than CDs, without taking on any more risk?"

My answer: none, never. If you want a stock that has less risk than a CD and returns more, I have news for you: it doesn't exist.

And an answer to some other comments on this thread: missing an opportunity to make a profit is exactly the same as taking a loss. Most people fail to see that. They will be happier with 3 trades that return $100 each, instead of a trade that makes $500, and two that lose $100 each.

Submitted by Chris Johnston on August 28, 2006 - 10:16pm.

Chris Johnston

ybc - blog address is http://iamafuturestrader.blogspot.com/ you can also get there via a link to it in the last paragraph from the home page of my web site, address to the site is above. You will have to dig for the May 10 or 11 post because it is in the archives, but it is there.

Submitted by no_such_reality on August 28, 2006 - 10:39pm.

In the 2000-2001 recession, the S&P 500 lost the following in each of quarter of 2001: -23.2%, -39.4%, -35.4%, -24.2%.

Bunk. The S&P 500 index closed on the first day of each quarter at the following:
Jan 2000 = 1455
Apr 2000 = 1505
Jul 2000 = 1469
Oct 2000 = 1436
Jan 2001 = 1283
Apr 2001 = 1145
Jul 2001 = 1236
Oct 2001 = 1038
Jan 2002 = 1154

The first quarter of 2001 lost 10%. The 2nd gained 8% and the 3rd due to September 11th got slaughtered for 16%, but the fourth pulled back for a 11% gain. The entire year saw a 10% loss.

2002 was a different story, Q2 & Q3 got walloped, combined losing 27%.

Submitted by ybc on August 28, 2006 - 11:23pm.

Chris, thanks. I can't believe that I didn't notice that you've posted your web address all along!

Submitted by lewman on August 29, 2006 - 2:48am.

I found it a bit interesting that some of you have very strong opinion about your own view and method and seem to suggest that it is mutually exclusive to others (e.g. keeping money in CDs vs shorting the market vs identifying sectors that'd still thrive despite a falling market). Rather I think they are just different investment methologies and risk management techniques that I believe could co-exist as that's diversification and diversification is always good.

I figure if I position my portfolio in anticipation of an upcoming recession, I'm eseentially relying on a crystal ball of some sort because I'm making a call about the future that as clear as it seems when the call is made the outcome could easily be totally different (and yes to state my position, as of today I'm one foot in the housing-led recession camp and am looking into how I'd ride the S&P500's fall in 2007).

At the same time I agree certain sectors could still work despite a recession and I'll continue to go long on these. Precious metals is one and I'm debating on oil. But this also requires a crystal ball.

These versus analysing seasonality (my research confirmed that an investment in SP500 during the fall of each of the past 9 mid-term years would be a win; this kind of percentages just can't be ignored) which does not require a crystal ball but does require a pattern in the past to continue to hold into the future. But for 2006, I'd like to see a deeper correction before I act.

For me, the objective is to make money without taking on too much risk while at the same time hopefully not missing too many opportunities due to "over risk avoidance". So I'll likely execute all three trades; make sure I have stop losses for all three and hopefully at least one out of three will be a win and the amount of profits will be greater than the losses ... rather than arguing to death that one method has to be better than the others and it's the only game in town.

Happy investing !

Submitted by PD on August 29, 2006 - 7:32am.

Just like everybody else, I have been trying to find the right investment mix. I was heavily long in stocks until early May, when I sold most of my stocks. I kept only the stocks that I felt would do well in a recession. Because I think housing is going down, I put some money where my mouth is and shorted two homebuilders and a lender. My trade was not very big, however. I recently bought puts on another homebuilder and a lender. I have the rest of my cash with USAA.

Submitted by powayseller on August 29, 2006 - 9:08am.

no-such-reality, bunk to you too. Just kidding....My data is correct. I'm using yoy.

luenglewis, my best way is mostly cash (various currencies), maybe some commodities (unless recession creates losses as demand declines), PMs once price comes down, and long on oil stocks or recession proof stock w/ low P/E. shorting is good for those who dare.

Submitted by Chris Johnston on August 29, 2006 - 9:19am.

Chris Johnston

SB/poway - there is absolutely no reason to be afraid of shorting, you need to get over this fear. I make more money on the short side than the long side when I measure all of my trades over time. Why? prices drop faster and more sharply than they rally in general. As a result you can get a bigger bang with less exposure ( time in the market risk ).

Submitted by lewman on August 29, 2006 - 6:03pm.

I suspect the fear of shorting has to do with the theoretical risk that losses could be infinite as opposed to going long where worst case scenario is just total loss. I think that becomes a real risk only if you short small companies so a relatively small amount of money can push the price through the roof. I just started shorting stocks about a month ago and I made sure these are fairly large companies. Plus I make sure there's a stop loss in place and between these two policies I hope I've reduced the risk of getting squeezed to a minimal.

But I would also look into PUT options as they come with a built-in stop loss mechanism. So I can execute the trade then go away and know that while I may lose my shirt, I will definitely be able to keep my pants on.


Submitted by lewman on August 29, 2006 - 6:21pm.

Powayseller, I noted you mentioned oil stocks. Are you attracted to oil stocks because of their low P/Es or is it because you think oil price will continue to rise or stay near these levels despite your conviction that recession is around the corner ?

Lately oil's been coming down hard and fast. Some attributes that to the loss of war premium. I'm not sure because the world, or specifically middle east, doesn't seem to be a safer place than it was just a few weeks or months ago. Rather, is it possible that oil traders are pushing oil prices down because they anticipate an economic downturn ?

And since oil prices is the main driver behind oil stocks. Would oil stocks still do well in absolute terms if oil prices were to level off ? If it does happen, the only way oil stocks will continue its up trend is a re-rating of the sector, i.e. the market assigning higher PEs to oil companies.

So many questions and so few answers.


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