Figure 4. Historical Stock Rebounds From Nine Recession-Induced Bear Markets

Interestingly, June of 1932 is the only time when the S&P 500 was further below its 200-day moving average, than it is today - and then it preceded a substantial move higher for equities.

To help provide some context to the current situation, Figure 5 shows a chart of an Exchange Traded Fund that seeks to replicate the inverse of the S&P 500. The ETF, not surprisingly, has gone nearly vertical recently and is well above its average price over the 200-days (blue line). The question investors should ask themselves is if this was an individual stock, do you think this type of parabolic move is sustainable?

Figure 5.  Chart Of Inverse S&P 500 ETF Looks Parabolic

With all this said, we can't know that stock prices can't or won't go lower. Among the most bearish estimates we have seen tossed around the Street is a level of 600 on the S&P 500. One of the simplest ways the bear case gets there is simply assuming the S&P 500 trades at a forward multiple P/E of 10x and then applying that to a below consensus earnings estimate of $60 (this estimate is well below the Street's current bottom-up estimate of $86). So let's say the bear case comes to fruition, since to be frank, they have been right so far. That would represent potential downside of 20% from Thursday's close of 752. Definitely possible, but we don't think it is the most likely scenario. But again let's assume it does happen. If that is the bottom, the previous table (see Figure 4) shows rebounds from recession-induced bear markets can also be very powerful and suggests there is a reasonably good chance that losses from here would be more than recovered over time.

Is there anything good or a potential catalyst on the horizon?

It's tough to say what turns this market around, but it almost always is without the benefit of hindsight.

1. The recent plunge in crude oil to under $50 has brought national gasoline averages closer to $2. As quoted in the Wall Street Journal, "Mark Perry, a professor of economics at the University of Michigan in Flint, sees lower energy prices as a continuing stimulus for the economy. Adjusting for inflation, consumers are paying less for gasoline now than they have paid throughout much of the past century. He estimated that at current consumption rates, Americans save $1.38 billion a year for every penny gasoline prices drop. That is about $290 billion since gasoline prices peaked in mid-July, and more than the tax rebates Americans received in the mail earlier this year."
2. Stock prices finally get to a point where investors with cash on the sidelines, even the bears, can't resist dipping their toe in the water.
3. Eventually tax loss selling should be finished and hedge fund redemptions should wane.
4. The Presidential transition phase is causing uncertainty and forcing some potential changes to be delayed, but that will be resolved in late January.
5. Signs of improvement in credit markets as government plans work their way through the system.
6. News that is still bad, but just not as dire as current expectations.
7. Announcement of a substantial stimulus package.
8. Some finality in the saga of the big auto companies.

Bottom Line:

What has occurred over the past year to equity markets has truly been tragic and is worst than the most pessimistic scenario that we could have painted. It makes us almost ill to see the S&P 500 and the Dow Jones Industrial indices trading with 7-handles (yesterday's close for the S&P 500 was 752.4 and Dow Industrials 7552.3), but as Mark Twain succinctly stated, "apparently there is nothing that cannot happen today."

The action in equities is much like what would occur if one pushed a boulder over the crest of a hill. With so much momentum in one direction, it is tough to pinpoint where the downward pressure subsides. It is understandable why some investors believe stocks will never do well again after the wreckage of the past year. But on the flip side, some investors thought the sky was the limit for Internet stocks, homebuilders, Chinese stocks, and most recently oil. Each of those investments had near parabolic moves and was more powerful and longer than what theoretically would be expected. However, in each case, once these assets peaked, the eventual corrections were very harsh and gave back a substantial part of the previous gains. In some ways, we believe the opposite is occurring now for equities. Although the healing process will likely require time, we believe investors with longer time frames of say, 4-5 years or longer, will be rewarded by owning stocks at current levels.

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