In The Grip Of The Bear.

Yesterday was another ugly day for stocks, with bourses around the globe falling victim to strong selling pressure. Fueling the sell-off were concerns that the economic recession could not only be deeper and longer than previously feared, but could also fall into a corrosive deflationary phase.


The MSCI World Index and the MSCI Emerging Markets Index fell by 4.6% and 2.2% respectively, tallying declines of 51.2% and 63.4% since the peaks of these indices in October 2007. Only the Chinese Shanghai Composite Index (+6.0%) and the Russian Trading System Index (+0.7%) bucked yesterday's declines.


As far as the US markets are concerned, the Dow Jones Industrial Index (-5.1%) plunged below the roundophobia 8000 level, resulting in all the major indices now trading below the recent lows of October 10th and 27th. This brings the lows of 2003 (Dow 7,524; S&P 500 801) and 2002 (Dow 7,286; S&P 500 777) into sight. A breach of these levels -- frightfully close to the current levels of the Dow (7,997) and S&P 500 (807) -- will wipe out the entire 5-year bull market from 2002 to 2007.


Interestingly, only 2.4% of the 500 S&P 500 stocks now trade above their 200-day moving averages. This line is often used as a crude indicator of the primary trend of a market or individual stocks. This often undeniably shows an extremely oversold situation, but bear markets have been known to stay oversold much longer than usual.


One can argue long and hard about valuation levels and earnings forecasts, but the extent to which stocks become undervalued in the grip of this bear is squarely due to the severity of the economic meltdown.


This is clearly shown by the relationship between the Dow Jones World Index and the Baltic Dry Index (graph above) – an assessment of the price of moving the major raw materials, including coal, iron ore and grain, by sea and generally an excellent barometer of economic activity.

The worrisome prospects for economic and earnings growth, together with the threat of deflation, are spooking the financial markets. The extreme level of risk aversion is illustrated by the US 3-month Treasury Bill rate falling to a minuscule 0.065% -- a clear sign of distress and fear -- and the yields on long-dated government bonds falling significantly in most parts of the world.


Next year there'll be a huge problem of unemployment, job openings will have disappeared, and every business will be going over its personal thinking in terms of who the business can do without.


Oversold conditions have so far not produced more than a temporary reprieve, and nobody knows how far down this bear market will fall. Until we see more signs of base formations being developed, one should tread very cautiously.


And remember the old Boy Scout adage: “Be prepared.”