Bottomless pit?

There was much rejoicing on Nov. 13 when the markets staged a huge late-day rally to finish with a big gain. The sigh of relief from Wall Street could be heard around the world as the S&P 500 ended the day up 6.9 per cent after dropping below the Oct. 10 intra-day low, touching 819 before the buyers took over.

Successfully retesting previous lows is regarded as an important indicator that markets have stabilized and are starting to form a new base in preparation for a new upward leg. The Nov. 13 recovery amounted to what technical analysts refer to as a double bottom, a W-shaped formation that is generally regarded as a sign of a trend reversal. But was this one really that significant? I didn’t think so at the time and said so that weekend in my Internet Wealth Builder newsletter. Unfortunately, I was right.

The drumbeat of bad news has resumed and stocks are back in a deep slide as investors continue to be hammered with depressing statistics. Some examples:

Sales of existing Canadian homes dropped 14 per cent in October and average prices fell 10 per cent, the biggest decline since 1982. U.S. retail sales set a record no one wanted to see, falling 2.8 per cent as fears increased that this may be the worst Christmas season since the Second World War. CanWest Global lost over $1 billion and announced 560 job cuts. Nortel topped that with a US$3.5 billion loss and 1,300 lay-offs. Even that was small potatoes compared to some of the job cuts in the U.S. and Europe. British Telecom announced it is eliminating 10,000 positions and even the supposedly recession-proof gaming business showed its vulnerability when Las Vegas Sands said it will slash 11,000 jobs in Macau.

Was there any good news? Well, Jeff Rubin, chief economist at CIBC World Markets, went out on a very long limb earlier to express cautious optimism that ” we can ride out the balance of the year without any further systemic shocks”. Writing in the Nov. 11 issue of Canadian Portfolio Strategy Outlook , he said that “China’s new fiscal stimulus package could add as much as 3 per cent to its growth next year, and the U.S. is about to follow suit”.

Rubin feels that the “grim” economic outlook for 2009 is already priced into the S&P/TSX Composite Index and that the rebound, when it comes, could be faster than anyone expects.

“Our 12,000 target for the TSX Composite next year would represent only a typically paced recovery, benchmarked to past cyclical yardsticks. It is certainly consistent with the nearly three-year period it has taken to fully reverse comparable percentage declines, although the rapidity of today’s crash may suggest, given the speed of market reactions, a more rapid recovery when the news brightens,” he said.

The best bet, he says, is oil stocks which will rebound when ” temporary market fears of demand destruction…quickly morph into more lasting fears of supply destruction”.

CIBC thinks it sees “signs of a bottom” and that view was echoed by former Federal Reserve Board chairman Alan Greenspan when he spoke in Toronto recently. But he hedged his comment with a cautionary note that we should all keep in mind: “I’m not going to forecast where we’re going because frankly I don’t have a clue.” If one of the world’s most-respected economic minds doesn’t know, neither does anyone else.

What is unquestionable is that we are in uncharted territory. We have not experienced an economic shock this serious since the Great Depression. Analysts keep telling us there are more differences than there are similarities between the Dirty Thirties and the situation today, but people can be forgiven for fearing the worst.

And not everyone dismisses Depression analogies out of hand. Former Goldman Sachs chairman John Whitehead told the Reuters Global Finance Summit in New York that the economic slump could be much worse than even the pessimists are predicting.

“I think it would be worse than the Depression,” he was quoted as saying in a Reuters dispatch. “We’re talking about reducing the credit of the United States of America, which is the backbone of the economic system.”

All this makes for gloomy reading, no question. But what else is new these days? My purpose in reciting this litany of woe is to reinforce my advice not to be misled by false dawns. There are always big rallies in the midst of bear markets – sucker’s rallies, they are called. Sometimes they continue for weeks, creating the impression that the worst is over and a new bull is in place. Then the slide resumes.

I continue to recommend using these rallies to reduce your stock market exposure if you are overweight in equities. If you have some capital gains on the books, offset them with capital losses. But be selective about what you sell. I agree with Jeff Rubin’s view that oil stocks will come roaring back at some point, perhaps sooner than we expect. I would not be dumping Suncor, EnCana, Canadian Oil Sands, etc. now.

We won’t know when the new bull market begins until after it has been in place for a while but I do not expect a long-range turnaround to start any time soon. So continue to stay defensive, build cash when you can, and wait.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, click here.