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Is the Market Oversold?

By Larry Doyle on February 25, 2009 at 4:45 PM in American Consumers, Current Affairs, Economy, Wall Street

The valuation of any asset is determined by three factors:

1. Fundamentals: measures items such as cash flow analysis, cost-benefit analysis, earnings before interest, taxes and depreciation (EBITDA)

2. Technicals: measured by regression of price movements to determine overbought and oversold conditions

3. Psychology: measured by unscientific surveys of market participants

I have never seen such divergent views on expected future earnings which directly impacts any reasonable fundamental analysis.

Differing technical analysis has the market in the slightly oversold category but not dangerously oversold.

Psychology remains remarkably balanced.

Add it all up and we have markets that are not so bearish and so oversold that they have no potential to go even lower. If markets were tremendsously bearish and oversold, then market participants would have sold out long positions and increased short positions thus cushioning the market from further selloffs. These developments have not occurred, although certain market mavens and asset managers would have you believe the market is oversold.

On the psychology front, I think it is beneficial to review an unscientific survey managed by Laszlo Birinyi. This survey comes out weekly and measures respondents’ bullish, bearish, and neutral outlooks. The bullish measures have moved down only marginally, bearish sentiments have moved up only marginally, and neutral sentiments have been fairly stable.

blogger-sentiment-survey

This unscientific survey is targeted at active market participants. Based on my experience, a lot of these surveys run together. Unless and until I see measures of bullishness approach the 25-30% area will I believe the market is dangerously oversold. That sort of move would be consistent with a market that is approaching capitulation.

Any questions? Don’t hesitate to ask!!

LD

  • Ellen D

    LD,

    How much does psychology affect the markets? I keep thinking of “irrational exuberance” carrying everything along in a sweeping tide. Are investors that emotional – doing everything by feelings – or are they just lazy and don’t do their homework in the other areas?

  • LD

    Ellen…all of the above. I believe that ultimately the markets are a reflection of our nation. Not enough discipline, too many people looking for the quick buck, and not enough people understanding risk.

  • fiscalliberal

    It is interesting in that none of the three points you mention address the aspects of fundamental needs to society, like food, shelter and safety.

    It is all the dream world of money and finance. So I would speculate we have more to go in terms of decline. Ordinary people can live with bartering and the utopia of Wall Street can come crashing down farther. We are not even near the depths of the depression in the 30′s.

    :-)

    • LD

      Fiscal…Perhaps I should have indicated that the “market” valuation of any asset is based on those three variables. There are clearly social values as well which are harder to quantify.

      Your point is well taken. Perhaps as a society we have been too focused on market values and not enough on social values.

      If we were to incorporate social values perhaps the market is oversold …but it can still go lower.

      I will say I did not have this sort of discussion on Wall Street. Thanks for the enlightenment!

    • NoBamaNoWay

      word. the “economy” consists of a good deal more than just the financial markets.

  • mountainaires

    I’m surprised the bullish percentages are so high. I think the market can go much further down, and I think it will go down. I don’t know what’s keeping it from doing so, except the psychology responding to the constant parade of Obama, Bernanke, etc. Or maybe people just don’t know how dangerously close to the precipice we are; I’m always surprised by how little people pay attention to the news, or get online and read a little bit. But then, most people don’t have time for all that–they’re so busy raising children or working multiple jobs just to keep up.

    • LD

      Mountainaires….Based on my experience whenever the bullish or bearish stats get near 25% or below it is time to either go the other way or merely realize that the market will work that condition off by moving sideways for a while.

      Your instincts are accurate.

  • Patience

    I can imagine the market being in a sort of limbo (at best) until we start to see just how the stimulus bill manifests itself. As well, we still haven’t heard any specifics about dealing with the credit crisis. And the mortgage bailout is expected by many to only provide an expensive, temporary bandage and that a very large percentage of applicants will be in mortgage default again after a few months. Then there’s talk of yet another huge spending bill coming out of Congress. So much yet that has to play out but not much to calm or instill confidence at this point.

    We are buying a [very] few stocks these days — many aren’t much more expensive than lottery tickets!

    BTW, when I hear or read advice from those in the business of selling or trading, why shouldn’t I take it with a grain of salt? Can they be trusted if they make money from transaction fees?

    With so much uncertainty about this administration’s solutions, who really knows what will happen, much less what to do?

  • sowsear

    I don’t see how anyone can be exuberant when the gov., after all of the money they’ve spent so far, keeps calling for more-as in a $410 billion(3/4 of it in earmarks) spending bill, then in the same breath talks about more money for the banks, when the stress tests they are suggesting have already been met and seem headed into new territory.

  • lizzy

    LD,
    Do these factors consider computer generated trades? I heard that when the market was at its most volatile computer programs had a strong impact on market moves. Real comment on discounting reality; I thought, “Well the market is only down 100 today.” Good analysis of what controls the market. Thanks.

    • LD

      Lizzy,

      Computer generated trades are ultimately like any other trade that factors into eventual closing prices. Granted volatility can spike when computer generated trades are activated.

      I was always of the opinion those model driven trades work until the model doesn’t work. The mavens behind those models will let you know that they are smarter than the market itself….until they’re not.

      • TeakwoodKite

        will let you know that they are smarter than the market itself….until they’re not.

        True human nature, LD.

        Thanks for the heart felt chuckle and the intersting post.

  • The Lochner Era

    The market is going to 5000 and below.
    Obama and Bernanke are throwing trillions at a problem that cannot be repaired. The only choice is to let it go. Let Citibank and BOA sink and let the “good banks” regional and community banks take their customers.
    It will hurt for the next 2-3 years but this is a cleaning that the economy badly needs.

    • LD

      Lochner…Interesting insights and I can’t say that I disagree with you. My sense is afetr watching testimony from Obama, Geithner, Bernanke et al is that the government is in the process of going “all in.”

      It will be the market forces on one side vs the govt on the other.

      • lark

        Bingo. That’s why the market is fretting, no?

        • LD

          yep…

          • lark

            I am scared LD. If tomorrow Obama also goes “all in” into the health care business to boss it around, then that’s two areas that government is interested in bossing us around. And then energy.

            I mean I knew it but it seems unreal when it’s happening.

            • Docelder

              The sad thing, I think the republicans that abandoned McCain also knew it and were counting on it. That being said, neither side see this anymore as anything other than a game. Somehow, someway a new party needs to come from this. Else, we really are done here.

              • lark

                I really wanted Hillary to act differently when she was dissed by the party but she acted like a punching bag.

  • Doc99

    IMHO the Market needs more Ben Bernanke and less Hopey One Kenobi.

  • felizarte

    Those making policies know the boat is sinking. They are throwing out lifeboats, but they also want to be the first ones in and on to safety before they allow the multitudes in. The masses will have to wait until the oligarchs are safely ashore.

    I only see more trouble, bigger ones ahead.

  • samb

    Well, someone said,”What goes up must come down”. the problem is no one want to be the first one to jump in Confidence just isn’t there and Obama isn’t a friend to big business,It should be interesting to see how he finds a way to make big business believe he is there friend instead of their gate keeper. I Won’t Hold My Breath.

  • Ellen D

    OK – I’m not a Financial Person (even though, ironically, I now hold a financial job, but there are some weird things going on if you put the pieces together.

    I read today that the guys at S&P were not allowed to look at the original records that these securities were based on (they were supposed to make up a rating anyway) and that these records were kept on some kind of computer tape. Apparently the originals are not around.

    At the same time, some consumer advocates are telling people to demand that their banks produce the original mortgage contract that their foreclosure is based on because so many banks can’t do that – they don’t know where they are.

    So we are giving money to banks when they can’t prove they even have these mortgages they claim they have, because so many have disappeared?

    What’s up with all this? Use the money for the FDIC to seize the banks and bring in teams of auditors to find out what the hell is going on at the subprime banks. It’s getting to look more and more like outright fraud every day.

  • anon

    I think the market is waiting for the tens of trillions in CDS contracts to be reeckoned. A lot of those CDS contracts probably have expiration dates approaching. If they can keep a “credit event” (nationalization, default, etc, whatever its defined as within the contract or generally accepted by the Derivatives Assoc. )from occurring and those contracts can expire first, the tsunami that would otherwise have taken down the world economy will have petered out.

    It seems like a chunk have already expired and given the several months of “stress test” (read: intentional delay of credit event) there’s a pretty sizable amount due to expire sometime this fall or year end. Because the CDS market is somewhere around 70 Trillion I doubt they’ll get clear of all of it but the may just be able to outlast the contract expiration dates for the terminal velocity tsunami.

    The market won’t return to “normal” until those contracts are reckoned though (either expired or paid off). Since CDS are OTC traded, the market can’t identify which companies are in the tsunami domino chain, only the recently formed clearing house would be in a position to know that and they’re not telling because to do so would defeat the whole purpose of the ‘wait out the expiration date’ plan. My two cents.

    • LD

      Anon…great insights. The CDS contracts are all “trade specific” so there is really know way of fully knowing where all the bones are buried.

      Bank regulators can determine but without a clearinghouse it’s one massive mess.

      • Linda C.

        Do we actually even have a 70 trillion world economy versus 70 trillion just in CDS? I really don’t think they know what they have, or how much money is tied up in these puffs of imagination. Our entire national economy is about 14 trillion, so do we really think there is 70 trillion in just CDS?

        • anon

          Yes 70 trillion+, internationally. They weren’t kidding about global collapse.

      • anon

        But there is a new clearinghouse, no?

        • LD

          they are working on it…under the for what it is worth category even though there may be 70 trillion in outstanding CDS tha is a “notional” amount the actual risk is FAR less…a LOT of those contracts would net out against each other…plenty are written on strong companies…plenty are likely very short maturity…thus the overall risk is still significnat but not 70 trillion significant or anywhere close…

  • Linda C.

    I think people are anxious to declare we “hit bottom”, but they did that when the Dow was at 8000 if I recall. We actually don’t know where bottom is yet. When this mess started I was figuring around 7200. However, as the news gets worse and the reality is slowly coming into focus. I have no clue.

    here is an article from Slate
    http://www.slate.com/id/1001832/

    • LD

      good link…thx

  • elise

    I’m very suspicious of so many of the people involved in “fixing” the economy. How can executives of so many large banks and industries be making so many poor judgements (ie costly retreats and spas) at this time? Another puzzle; Allen Greenspan was always so careful in his public remarks until just before his retirement and Bernanke has talked about catastrophe almost from the beginning of his appointment by GWB. If perception and psychology are important factors in the valuation of assets, why would “experts” and politicians be so publicly negative? I think I asked before about the rumor Asia may be considering the issue of a new currency similar to the Euro. So many of these experts, including Geitner, are members of the same organizations and have similar views including a remark made in January, by Soros, that the dollar will not be the global instrument of credit in the future because of this financial crisis. Doesn’t this mean the very people in charge of making decisions to fix the economy, have a negative view of the future and may be more committed to preparations for failure than success? Is it really possible to change the psychology simply because Washington has changed it’s message of gloom and doom to hope and optimism?

  • TeakwoodKite

    Timmy the Turbo Man was McNeil doing damage control.

    Very bizzarre. He was asked about the government “owning” a percent of a bank proportional to the “bail out”. The word was “nationalize” that Lehrer, to wit tim did not knock it down.

    They don’t have a plan or very many of the “blanks” filled from listening to Turbo Man. UG!

  • anon

    Hey LD,

    Thanks for your earlier response. Isn’t the Depository Trust and Clearing Corp. the new destination for all (global) CDS contracts? Certainly its being used by domestic and foreign parties but maybe not all, was that what you were saying?

    Obviously seeing the terms of the contract are the sticking points, definitions and time frames.

    • LD

      Anon…I know that a clearinghouse is being worked on but I was not aware that they had yet made any change. Additionally a clearinghouse can only work on contracts that are of similar terms. A lot of the contracts have different terms.