It was another challenging month for stocks, with three month returns from August 31st through November 20th the worst in 80 years. On November 20th, US stocks closed at a level last seen in April 1997. However, stocks rallied 17% over the next 5 days, still leaving the S&P 500 down 7.2% on the month, down 22.8% on the quarter and down 37.7% on year. Economic news continues to be horrible, but stocks rallied simply because hedge funds appear to have stopped selling.
The #1 question our clients have asked over the last few weeks: "Can we sell all stocks now, step back into the market when things calms down?" The problem with that strategy is that, as volatile as the market has been to the downside in the last three months, we've seen 4 occasions where stocks have gained 10% or more in very short time frame. So rather than protecting our clients against further losses, more likely we would sell stocks low, only to buy back later at higher levels.
From a technical point of view, the good news is that the Dow Industrials at 8000 and the S&P 500 at 800 seem to be the hard floor of this particular bear market. We've broken through those levels a couple of times, but each time the market rallies back hard the next day. As we have discussed in other recent commentaries, stocks remain exceptionally undervalued even if we discount next year's earnings expectations by a third.
Housing remains at the root of all the current problems. The rate of decline in home prices accelerated sharply in September and will also probably show a sharp decline in October as funds for mortgage lending dried up completely. The rate of decline should slow when November's numbers are reported (in February.) The hardest hit areas include California, Nevada and Florida, with prices down 36% from 2006 highs. Up to half of all sales in those states are foreclosure sales, which may overstate the total decline as foreclosure sales are generally at a discount to local market conditions.
The latest Treasury program, which addresses tight credit conditions by intervening directly in the home mortgage, car loan and credit card markets, caused mortgage rates to drop 0.75% in a day. This program purchases newly originated loans directly from the banks, which can make quick profits without worrying about getting stuck with depreciating securities. This is another step in the ongoing nationalization of the US financial system, but necessary as the banks are unwilling or unable to do the job themselves.