Risk Premiums for The Dow Indices: WHY BUY STOCKS?

For the Week Ended:  November 14th, 2008

THE 10-DAY POSTMORTEM

A postmortem of market behavior for the week ended November 14 suggests that equities as measured by stock indices continue to display volatile price activity on an intraday basis as well as closing figures.  Our Risk Premium Index is not a risk volatility measure, per se.  Rather it is based on the value of asset classes of which two major components are stock values and the yield on fixed-income securities (including preferred shares).  This generates the frequent question from our clients: is this the bottom of the bear market and is it time to start accumulating stocks?  We continue to caution “bottom-feeders” that the price and volume gyrations experienced since Barack Obama won the presidency on November 4th have failed to provide bullish signals in the Dow Industrial, Transportation, and Utility Indices, as shown in the figures below:

§         The Industrial Risk Premium for the week ended November 14^th advanced to 9.77% versus 9.28% in the prior week

§         Over the same period  the Transportation Risk Premium reached 9.36% from 9.15%

§        Finally, the Utility Risk Premium number moved higher week-over-week, closing at 8.96% versus 8.78%.

WHAT’S AN INVESTOR TO DO?

Our view is that this bear market has plenty of steam left and that a bull market is unlikely to emerge in the next three to five quarters at a minimum. What does this mean for investors?  The good news is that equities may get even cheaper and that non-governmental fixed-income securities could offer yields not seen in two decades. Skillful investment strategies, paramount of which will be sticking to high-quality stocks and fixed-income instruments, might enable investors to achieve above-average rates of return.   In an environment where fundamentals continue to weaken and with the post-election euphoria subsiding long-term investors are well advised to seek out securities which can be used strategically to cushion the short-term market gyrations as well as offer price appreciation potential.

THE POST-ELECTION RALLY THAT DID NOT HAPPEN

Strong Election Day gains (the biggest Election Day rally in 24 years) were followed the next two days by a sharp decline in prices, representing a departure from the historic performance of stocks which have typically advanced when an unpopular administration and party are voted out of office. In the two trading sessions following the election the Dow lost 929 points before posting a 248-point gain that Friday, paring net losses for the three-day post-election period to 376 points, with the Dow Industrials ending the week at 8,943.81.  This election is best characterized as a vote for change at a time of great economic uncertainty and turmoil which continues to manifest itself in the markets. Food for thought: takeover of the White House by the opposing party over the past 50 years has resulted in the market bottoming out two years later with the exception of 1994 when it finished flat.

Investors hoping for a post-election market bounce have so far been sorely disappointed. In point of fact, the Dow and other market indices are testing lows and have been unable to hold gains. On this point, we feel it is possible for the Dow Industrials to fall into 7,000-point territory over the next five or six quarters. Indeed, as noted earlier, our Risk Premium Model has yet to give a bullish signal.  As of the close of trading on November 14^th the Dow stood at 8,497, 1,128 points below its 9,625 Election Day closing.

INVESTOR UNCERTAINTY

We noted in our previous Risk Premium write-up, “From Rhetoric to Reality” (November 5, 2008), that the Democrats have taken on a huge burden, the most pressing of which are restoring the economy to health and bringing the costly Iraqi campaign to an end.  Over the past 10 days, investors have been looking for President-Elect Obama to show his hand on his economic policy plans which will undoubtedly be reflected in his cabinet and staff choices. With an unusually weak lame duck president in George Bush the future president is facing great pressure to move quickly to calm the fears bedeviling the markets both here and abroad.    We believe the longer the president-elect takes to say what he intends to do about economic and international issues, the more likely it is that investor confidence will continue to erode.

BURNT OFFERINGS

With regard to taxes and entitlement programs, Obama seems to be on the horns of a dilemma.  On one hand, his pre-election campaign promised a major realignment of tax rates in order to achieve what appears to be very close to a redistribution of wealth.  On the other hand, recent rhetoric indicates that he sides with programs which would have the Internal Revenue Service (IRS) refund dollars to the public.  There appears to be a contradiction in economic objectives between increasing tax rates (which would have the effect of lowering consumer discretionary income) yet at the same time pumping one-time checks back into American households.

The crux of the problem is that distressed householders need more than a one-time infusion of cash in order to restore financial viability.  The average American, particularly homeowners, needs to strengthen their debt-servicing ability. This could probably best be achieved by restructuring various lending arrangements starting with renegotiations of current home mortgages. Until the downward spiral of house prices and rising foreclosures can be halted asset values (yes that includes equities) will remain under negative pressure.

THE LONGEST 77 DAYS

Continues ▼

Continues ▼

Continues ▼

For Additional Information or Questions Please Contact Us.