Ted Olshansky began his investment career in 1968 as a registered broker with Dean Witter & Co., Inc. Mr. Olshansky was a market maker and member of the Chicago Board Options Exchange (CBOE) from 1975 to...
Publish Date: July 31, 2007
Ted Olshansky
If you didn't know the market had a bad week last week your head is probably in the sand. And you don't need me to tell you that.
What we are going to do is examine some of the causes of the decline and what we can expect in the near term.
One of the factors driving the market has been liquidity, that is, Wall Street's seemingly endless pocket of money to fund deals. The collapse of the 12 billion take over of Chrysler's auto operations by Cerberus was one of the reasons for the stock market decline. The financing machine of Wall Street which has facilitated take-overs and helped many companies with problems has ground to almost a complete halt. As the junk bond market has been slammed, this of course makes any prospective deal much more expensive.
Next, the slowdown in housing affects many areas of the economy as weak house prices reduce consumers' desire for high priced purchases and it has been the consumer who has surprised many economists by their continued strength. This strength probably will not continue. Although we have seen a slowdown in the quantity of unsold homes, most economists believe that the recovery will be slow and gradual beginning in 2008. Lenders are also becoming more strict especially on undocumented loans. No longer is a bank willing to fund 100% of the loan or even 95%.
As for the sub-prime lending problem, it is a relatively small part of the total picture. It has already been with us for a couple of years. Like other problems during the past several years, we will survive this one.
And let's not forget that there is a presidential election coming up in a little more than a year. With the Democratic party the favorite, we are hearing rumblings of changes in the capital gains tax, higher income taxes and remember how they love to bash the tobacco and drug companies. These proposed tax hikes coupled with the above can account for much of the selling last week. (July 23-27).
Now, let's take a look at where we are. In the last 4 ½ years the market has risen just under 100%. This was fueled by low inflation, low interest rates, solid growth in earnings and GDP and a never ending buy back of stock by listed companies. (Naturally other factors were involved but we don't have the time or space to discuss them all.)
We still have the above favorable factors although some slowdown is certain. Estimates of S&P earnings growth have fallen from about 9.5% to 6-6.5%. But with S&P earnings estimated at approximately $94, the index is trading at a modest 15 P.E.
Markets tend to go to extremes. We saw this in 2000 and in the two year decline that followed. And now we have seen the market close over 14,000 (Dow Jones Average) only to fall back for some of the above reasons. It is this writer's opinion that we may see the selling continue to approximately the 12,850 level on the Dow. That would be an approximate 8 % correction which is normal and should be a buying opportunity. Why?
Those who say interest rates are going higher haven't looked at the 4.75% yield on the ten year bond. Yes, mortgage rates are higher but the important ten year bond is not. Earnings growth has slowed but not dramatically. Inflation has not reared its ugly head. As reported by Morgan Stanley, July 23, 2007, the May core PCE deflator, the Fed's preferred measure of inflation was up 0.1% (vs. +1.9% a year earlier) falling below 2% for the first time in two years.
On the earnings front, this past week saw Apple's earnings rise 73% on a 24% increase in revenues and Boeing moved to over a $1 billion profit. A very good showing for two important parts of the economy.
We are still bullish and would use any break of the DOW under 13,000 to establish new positions.
"Keep your head on while everyone else is losing theirs." Author Unknown
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