May 1, 2008: Article by Bob Norton.  ECs (Editor's Comments): by Kirk Lindstrom

Bob Brinker LT Shadow Stock Market Timing Model Update for May 1, 2008

Averaging Evergreen ($85) and S&P guidance as of 4/28/08 ($91.69) gives $88.34.

Dividing current S&P level of 1385 by my median earnings estimate of $88.34 gives us a current market p/e of 15.67.

The S&P earnings yield (1/15.67  = 6.38%) continues to compare favorably to the yield on the 10 year Treasury (3.76%).

Investor's Intelligence (Bulls/Bulls + Bears) has risen above the .500 for the first time in eight weeks.....present level is still a very pessimistic .523.  The Morningstar Valuation Graph has been bouncing around the deeply under-valued level since the middle of January. 

Monetary Policy:

EC: Bob N. has the Monetary Indicator as neutral in recognition that the Fed is trying to improve the situation.  Last month I had it as bearish because cutting rates seemed to only be stimulating more inflation while long term rates people get for mortgages were not coming down. The Fed was willing to accept this for now because they feel it is easier to cut inflation later by raising rates than it is to save an economy that falls into a deflationary depression which we could get if all the banks were to stop lending money.

Currently monetary growth is tight but mortgage rates have started to come down but reports say it is hard to get loans even if you have great credit.

• See:  Best Mortgage Rates for the current update of National Overnight Averages of mortgage rates.
• LIBOR Rates are down but the 1-yr jumped from 2.39 to 3.07% last month!  This won't make it easier to get loans and will make the reset rate for AMRs higher so those in homes who can afford to say will have less money after making higher mortgage payments.
  

EC continues: Inflation needs to come down for long rates to drop.  Lowering the Fed Funds rate is inflationary so lenders will want assurances inflation is contained before they will accept lower rates.   The Fed lowered rates yesterday to 2.25%.  We need to see signs the economy is bottoming and even turning up so the Fed can talk about raising rates to satisfy the inflation hawks so the long rates can come down and people can get affordable home loans.  We are seeing progress, but not enough for me to put it at neutral.

Remember The bear market in housing has been made worse by a meltdown in the credit markets so I currently have the "Monetary Policy Indicator" as BEARISH.   

If this does not change from Bearish to Neutral and the market continues to rally, than I expect I will go into profit taking mode before we see new all time highs again.  This is far different than Bob Brinker who was fully invested at the top and prefers to ride these corrections or bear markets up and down fully invested.

Serious slowdown/recession.....call it whatever suits you.  Mr Market has already acknowledged that we have arrived. Evergreen Investments has altered their stance in that we will we will probably NOT avoid slipping into recession territory.  Evergreen, however, does maintain that the massive stimulus injection will take hold in the 2nd half of the year and into early 2009.  This stance is consistent with other sources I have been following.

BUT TAKE NOTE.....Evergreen has concerns about a "double-dip" later in 2009 as the stimulus effects begin to fade.....not to mention my concerns about what happens to the health of the stock market if concensus future inflation projections turn out to be wrong.

From Wachovia Bank:


Curiously, March data on industrial production and retail sales would seem to contradict the widely held view that we have entered recession.  Both indicators made a slight rebound from the February readings.  We will have to wait for definitive signs that the slowdown/recession will not morph into anything truly serious.

Today the government released the advance number on 1st quarter GDP and it came in at a POSITIVE 0.6%.  If the eventual adjusted number stays in positive territory, then I may return this indicator to a bullish stance, but for now.....

EC:  Obviously, Brinker was wrong last year when he said there would not be a recession and predicted the stock market was a buy in the mid 1400s as it was making new highs.  These days Brinker says there may be a recession and the market is a buy in the low 1300s.  The timing model requires "accurate predictions of the future" which is why so many (including me) say market timing can't be done reliably over and over.  This indicator should have been bearish last Summer and Fall to correctly predict the collapse of the housing market, the collapse of major investment banks, a terrified Fed cutting rates like crazy to try and prevent deflation AND conservative Republicans agreeing to throw money at tax payers to stimulate spending.  Brinker did not predict any one of these events which would have had him taking some money off the table if he knew the S&P500 would fall 20.2% so far on an intraday basis.

We will have to endure 2 quarters of very slow to negative growth before witnessing a return to a positive growth trend. Once the monetary and fiscal stimulus begins to flow through the economic pipeline, it will act as a catalyst for equity recovery into the mid to upper 1400s, at minimum.  Investors could see a breakout beyond this range, but any such extension beyond these limits probably will be short-lived.  Evergreen characterizes this anticipated move to the upside as a relief rally fueled by massive stimulus which may ultimately meet resistance by mid 2009.

On April 4th, Federated Investors called for the S&P to reach the 1550-1600 range this year for a mid to upper single-digit gain on the 12/31/07 close of 1468. In my opinion, this may be a touch too optimistic right now. An S&P recovery near or above 1500 would definitely call for a new stock market risk assessment.   

As stated last month, the outlook is subject to adjustment depending upon how earnings continue to develop.  1st quarter earnings have been reacted to favorably by investors.  Even results for Financials have not been "as bad" as Mr. Market was bracing for.

Will inflation trend forecasts by Wachovia, Wells Fargo and others hold true in the coming months? Will the economic slowdown/recession keeps a lid on the Federal Reserve's favored core inflation rate?  My biggest worry is that oil prices in the $115/barrel range will begin to hit the core inflation numbers and will cause an about-face strategy on the part of the Federal Reserve.

And if that happens.....LOOK OUT BELOW!

EC:  Thanks Bob for another excellent analysis.      

Summary: Bob Norton's "Shadow" Long Term Stock Market Timing Model has  2 indicators bullish and 2 neutral. Last month he had 2 indicators bullish and 2 neutral.

I too look forward to comments others have.  Personally, I think the whole exercise proves why market timing over the long term to add value is nearly impossible.  I like to do it as the sentiment part helps me take profits when the markets are high and buy when others are scared and the market is down but that is more rebalancing than anything else.

For most of the 1990s Brinker said if he saw a bear market coming that he would go to 100% cash or even net short the market.  He went so far as to tell his subscribers to get information from a mutual fund that shorts the market so they are ready to buy should he recommend that fund.  I have to question the validity of a timing model that with all its improvements "only" went to 65% cash just before the worst bear market since the great depression and then allowed as much as half what was taken out to be placed into QQQQ just before it collapsed from $87 to 19 in the next two years.

BTW, if anyone wants to see what my monthly newsletter sentiment update looks like, then check out this PDF file: "Take Profits & Sell Sentiment Indicators from The Market Top." The page of my newsletter is from last year with the markets near an all time high at 1540.

The S&P500 was at 1540 when I said take profits in my monthly newsletter shortly after we had all five of the indicators say BUY on a correction.

In March I added SPY to my newsletter explore portfolio at $130.61 and today it closed at $141.11.  I don't know what the short term hold for the market but if we continue higher, then I will again take profits when my indicators and asset allocation tell me to do this.

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