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Risk Premium:
RUNNING ON EMPTY
For The Week Ended
July 11, 2008
THE BEAR MARKET HAS
“OFFICALLY” ARRIVED
The Dow Jones Industrial Average dropped 188.00
points this week (-1.67%), falling to 11,100.54 thereby meeting the
requisite 20% decline needed to be “officially” declared a “bear”
market. Since reaching its
record-high close on October 9, 2007 of 14,164.53, the Dow dropped past
the 20 % threshold at several points during the week, finally closing
out the shortened trading week 21.63 % down from its all-time high.
The Dow’s fall paralleled that of the other major market indexes
such as the broader Nasdaq and Standard & Poor’s 500 (S&P). Since
October 2007, the Nasdaq Index has also slipped into bear market
territory, down 21.69%, whereas the S&P 500 is off 20.81%.
We continue to caution about the treacherous
nature of this market slump. We feel that portfolios should be
overweighted toward cash in order to deploy funds as opportunities
present themselves. Until our
risk premium model begins to provide bullish signs we think investors
should hold onto their cash since stock prices are likely to fall
further. Since our model
suggests that the Dow continues to have more downside risk, we do not
rule out the possibility of it falling below 11,000.
NOTHING MAGICAL ABOUT THE
20% RULE
A fall of 20% or more from a high is a common
belief held by many investors to confirm a bear market.
Our Risk Premium Index model began signaling a bear market in
August 2007 and remains in bear market territory.
Since the 20% rule is loosely based on empirical evidence, we
hope investors were not waiting for one or all the major stock indexes
to fall in excess of 20% before coming to the realization that a bear
market was underway.
BEAR MARKETS ARE NOT TO
BE TRIVILIZED
In practical terms, it is very difficult run-up in
stock valuations, with
P/E ratios in to invest profitably during bear markets
although, over time, values will start to emerge.
Bear markets are not to be taken lightly.
For example, the 1973-1974 slump lasted 694 days (23 months),
with the Dow down nearly 45%. It affected major stock markets throughout
the world. By contrast, the
1987 bear market began with a bang and was of a relatively short
duration. On Black Monday
(October 19, 1987), the Dow plummeted 508 points, losing 22.6% of its
value in one day, while the
S&P 500 dropped 20.4%, and the Nasdaq 11.3%.
The 1987 crash is believed to have been caused by an unwarranted
valuation the U.S. significantly above the post-war average.
The S&P 500 was trading at 23x
earnings, a postwar high and well above its average of 14.5x earnings.
WHILE WE WERE
CELERBRATING JULY 4TH
While we were celebrating the July 4th Holiday,
stocks in London approached official bear market status.
The FTSE 100 Index closed at 5412.8, its lowest level since
November 2005. The U.K.
benchmark has declined 19.6% from its high reached in October 2007.
Whether or not the FTSE breaks through the 20% threshold is not
especially relevant. What is
obvious is that stocks in many countries are not performing well.
The weakening economies in Europe, Asia and the U.S. have the
same common denominator, namely, the escalating cost of energy (i.e. the
run-up in oil prices) which is bleeding businesses as well as consumers.
RISK PREMIUM STATISTICS
§
The Industrial Risk Premium
ended at 1.32% versus 1.31%
§
The Transportation Risk
Premium decreased to 4.52% from 4.53%
§
The Utility Risk Premium
decreased to 6.34% from 6.37%
n
|
Date |
July 3, 2008 |
Date |
July 11, 2008 |
| DJ
Industrial Risk Premium |
1.31% |
DJ Industrial Risk Premium |
1.32% |
| 30 Year
Treasury |
4.53% |
30 Year Treasury |
4.47% |
|
Industrial Risk Differential |
-3.22% |
Industrial Risk Differential |
-3.15% |
| |
|
|
|
| Date |
July 3, 2008 |
Date |
July 11, 2008 |
| DJ
Transportations Risk Premium |
4.57% |
DJ Transportations Risk Premium |
4.48% |
| 30 Year
Treasury |
4.53% |
30 Year Treasury |
4.47% |
|
Transportation Risk Differential |
0.04% |
Transportation Risk Differential |
0.01% |
| |
|
|
|
| Date |
July 3, 2008 |
Date |
July 11, 2008 |
| DJ
Utility Risk Premium |
6.37% |
DJ Utility Risk Premium |
6.34% |
| 30 Year
Treasury |
4.53% |
30 Year Treasury |
4.47% |
| Utility
Risk Differential |
1.84% |
Utility Risk Differential |
1.87% |
Continues ▼
Continues ▼
Continues ▼
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