Raw Finance

Over the weekend, David D. Moenning of Top Guns Trading, issued a newsletter in which he outlines seven reasons why the stock markets are suddenly declining again.  The reasons are listed below, but I think that most readers (and Moenning himself) would agree that none of these are a surprise.

My point is that last year, we were blindsided by the Lehman Bros. bankruptcy and the crushing ripple effect that froze credit markets.  Uncertainty reigned as no one could predict whether the financial industry would survive, especially when AIG nearly failed thereafter (but for a federal government bailout).

This year, the problems in the economy are well documented, and even though there may be disagreement about how well the recovery will come along, there are few who doubt that a recovery is underway.  At some point the National Bureau for Economic Research (NBER) will announce the official end of the recession, which began December 2007.  Will stock markets zoom higher once this announcement has been made?  Not necessarily, according to Bespoke Investment Group LLC, though a steep decline is not likely either.  In a recent research report, Bespoke noted:

Looking back at the prior four recessions since 1980, we found a mixed record of performance by the S&P 500 and its ten sectors. As shown below, in the year following the official declaration that the recession was over, the S&P 500 has risen twice and declined twice. However, we would note that in three of the four periods, the S&P 500’s performance in the year after the official declaration was worse than in the period between the end of the recession and the official declaration. Based on history, the gains we’ve seen since the recession supposedly ended will be hard to beat once the NBER makes it official.

It seems that in the post-recession investing environment, generally investing in the stock market through index funds will only provide the same sideways move the market has seen over the past ten years.  If the 18-year bull/bear market cycle continues to prove to be the rule, the current long-term bear market, which began with the tech-bust in 2000, will most likely end around 2018.  Thus, we have about 8 more years of challenging conditions.

Moenning’s 7 reasons for the current market decline, and possible correction, are also likely reasons why investing conditions will remain challenging into 2010:

The Not-So Lucky Seven

 Reality Check for Economy. Thursday’s GDP report, which initially prompted a chorus of “Happy Days are Here Again” from word that the economy grew at an annual rate of 3.5% in the third quarter, served as a wake-up call of sorts on Friday. Although, it was nice to see the number come in better than expected, when you dug into the report, one of the big questions became: Is this going to be sustainable going forward?

This, of course, brought about cries of “too far, too fast” and “the market is ahead of the fundamentals” from the bear camp. But in reality, they may have a point as few rallies in history have traveled as far or as fast as the March 10 – October 19th run for the roses. And since everybody in the business knows that we are overdue for a meaningful correction, it is little wonder that the buyers simply stood aside on Friday.

The Passing of the Buck: Perhaps a better heading for this section would be “Dollar Carry Trade Starts to Unwind.” But in reality, that sounded awfully technical (and more than a little dull). However, it is the idea that big-time traders around the world have either borrowed dollars at our bargain basement rates to buy other assets, or are flat-out short the greenback that is a part of the problem. As we’ve seen over the past several months, the advent of the “dollar carry trade” has meant that when the dollar is falling and stocks are rising, everything is hunky dory.

But, a rising dollar and/or rising interest rates puts a crimp in the profitability of the carry trade. And with traders around the globe beginning to worry about the economic recovery theme, they naturally gravitate to the world’s safe haven currency – the U.S. Dollar. So, with the dollar actually getting a bit stronger and the economy not looking so solid, the programs kick in and stocks get sold.

Wake-up Call For Banks: Calyon’s Mike Mayo came out with a report on Friday suggesting that Citigroup (C) might need to write down as much as $10 billion in something called deferred assets in the fourth quarter. And while analysts quickly came to Citi’s defense and the bank itself called the idea preposterous, the report reminded investors of the fact that the balance sheets of America’s banks are still a mess (and maybe a little of the stonewalling from Lehman and Bear).

Then There is Commercial Real Estate: Speaking of problems with the banks, renowned investor Wilbur Ross said Friday that commercial real estate is a ticking time bomb for the banks. While this is hardly a new idea, it is indeed something to worry about. And since the market is suddenly in worry mode again…

Speaking of Worrying: One of the bear camps’ favorite themes is the idea that the consumer is not showing signs of life. Since households, unlike corporations, can’t go out and issue stock to pay down their debts, they have to tighten their belts. And with just about everyone expecting the next cycle to be a “jobless recovery” it is hard to see what it going to put the consumer back in their happy place – aka the shopping mall. So, with the October Jobs report on tap next week, investors may be worried about what might be in the Big Kahuna of economic releases next Friday.

Looking For the Exits? Another issue cited for the current corrective action in the stock market is the concern that the Fed may soon start looking for an exit strategy for its ultra accommodative monetary policy. Late last week, the Financial Times ran an article suggesting that Bernanke & Co. may change the language in their statement accompanying next week’s rate decision. Although the move is inevitable, traders worry about the concept of taking away the punchbowl too soon.

The Tape Tells All: Market technicians argue that there is no need to worry about any of the above. No, the chart watching crowd prefers to watch the wiggles and giggles found on their screens instead of worrying about such trivial things as fundamentals. While you may find this amusing, we’ll bet you can’t name three investors that don’t at least look at a chart before making an investment decision. The point being that chart watching has become prevalent in today’s investment world.