RISK PREMIUM STATISTICS

RISK PREMIUM ANALYSIS: WALL STREET INFECTS MAIN STREET

For The Week Ended:  October 3, 2008

In the first full trading session following the passage the $700 Emergency Economic Stabilization Act by the U.S. Congress, stocks continued a four day losing streak. The Dow Jones Industrial average lost 817.75 points (or 7.3% of its value) in a single week, ending October 3, 2008 at 10,325.38.  Investors should seek safety by purchasing stocks having super-high financial quality and a long holding time horizon.

WHERE IS THE BOTTOM?

I am a bit weary of answering this question since as soon as our Risk Premium Model signals a “bottom,” subscribers of Whitehall Services will be the first to know, including those receiving complimentary copies of our weekly Risk Premium Analysis. On September 19, we cautioned that our Risk Premium Model had exhibited impending extreme distortions in stock prices.  Due to the magnitude of change indicated, we felt it best to downplay the results.  The Risk Premium for Industrials, Transportation and Utilities actually surged higher (see Charts at end of text), pointing toward significantly lower equity prices.

Perhaps the most note worthy event during the week was the 777.7 point decline on Monday, September 29^th when the House of Representatives failed to ratify the initial rescue plan, Troubled Assets Relief Program (TARP) by a vote of 228 to 205.  Were we surprised?  In a word, No.  On Sunday evening, Speaker of the House Nancy Pelosi reacted to the draft proposal in the most partisan an imperious manner I have ever heard. (...I actually had my back to the TV to see who was speaking was pedantic, almost like a mother chastising her Children for getting their hands stuck in the Cookie Jar.)  It was very obvious that her understanding of economics was not merely seriously lacking but non-existent (...in all fairness to the Speaker, she is probably not alone and in “good” company.)

Politicians Must be Allowed to Panic. They Need Activity. It is Their Substitute for Achievement.

This Congressional notion that Wall Street and Main Street are somehow separated, when in fact, Wall Street is a conduit through which Main Street channels its wealth and stores its savings in the form of stocks and bonds.  Moreover, the flow of money (i.e. liquidity) is not a worry for major corporate entities but individuals as well.

Recently, there was a Wall Street Journal article recanting the problems caused to a party when AMEX reduced his business line of credit to $500 from over $20,000, despite an impeccable credit history with AMEX and no change in his credit score.  Extending this micro example to major corporations that the public depends on, should clearly illustrate the need for credit to readily flow and that orderly markets for stocks and bonds are maintained not for Wall Street but for Main Street (...perhaps we should impose competency tests on elected officials before we vote them in office?)

We have held for months that this is treacherous market and that stocks had yet to see their lows: the proverbial “bottom.”  Unlike other bear markets, which tended to be driven by earnings slumps, this market is not only facing uncertain corporate earnings but a concurrent, virtual shut down in the credit markets which jeopardizes the solvency and liquidity of many otherwise healthy businesses.

THE DOW AT 9,500

In our September 19, 2008 report entitled, “When Stress Turns To Distress,” we reluctantly disclosed that our model showed the Dow Jones Industrials could fall to 9,500.   On October 3^rd, 2008, our Model was once again vindicated when the Dow reached an intraday low of 9,503.10. In our comments we acknowledged:

Based on the “daring” and “lonely” prediction I made in August 2001 that Enron was in grave trouble (... being correct can be a very lonely and lethal place), we made the decision to limit the low on the Dow Industrials to 11,000 despite a much lower figure suggested by our Risk Premium model.  As a result we have continually cautioned investors that the long awaited “bottom” to this bear market had not yet been reached and that we would not be surprised to see the Dow break 11,000, which it has done repeatedly in recent months, only to erratically bounce back over and over 11,000.  With considerable trepidation, we are releasing the latest value results from our model, the result is that the Dow Industrials may decline even further, possibly approaching the 10,000 level and at the extreme 9,500 (about 1,500 points lower from its current level).  Much of the recent market behavior appears to be backing and filling in conjunction with investors who are all too eager to jump on the latest headlines before taking the time to really think of the possible ramifications of using a hair trigger response to any information irrespective of the source.

The Dow managed to rebound and is now trading in the 9,700-9,900 range, which begets the question: is this the bottom and are stocks oversold?  The answer: no, not quite yet. The simple answer is that the bear market is not driven by earnings but by the U.S. and world economies coming to a “stall,” which is rooted in credit quality and lending willingness.  Ultimately, financial flexibility as reflected in the quality of Balance Sheets has long been trivialized and until confidence in Asset and Capital quality can be restored, it will be very difficult to conclude that stocks are or are not oversold.  We feel our model, despite its 30-plus years of service, still yields reliable results and therefore we are not prepared to abandon it.  In short, the data suggests that stocks are not oversold and there is further downside, as measured by the Dow Industrials. There could be another 500-to-1,000 point move downward from here.

§         The Industrial Risk Premium ended at 7.89% versus 7.51%

§         The Transportation Risk Premium increased to 8.19% from 7.91%

§         The Utility Risk Premium increased to 8.39% from 7.76% n

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