Volatility: What Is It Telling Us?

(page 2 of 2)

Volatility Spikes and Market Bottoms

Story Tools

• post a comment
• e-mail this story
• print this story
• order a reprint
• digg this
• save to del.icio.us

We see inflation-adjusted gross domestic product (GDP) declining during the first half of 2008, but then advancing in the second half as a result of the economic sugar rush offered to American consumers in the form of a tax rebate, as well as the effects from a year's worth of Fed rate cuts. The yet-to-be-resolved worry is whether U.S. GDP growth will again slip into negative territory once the tax stimulus has worn off.

Fundamentally, we don't expect to see 2008 go down in the S&P 500 earnings annals as a repeat of 2007. S&P equity analysts project the market-cap weighted S&P 500 to post a 16.5% increase in EPS for the year, led by double-digit EPS recoveries by companies in the Telecommunications Services, Financials, and Information Technology sectors. Eight of the 10 sectors in the S&P 500 are expected to see double-digit earnings growth in 2008, with only the Industrials and Materials sectors likely to see single-digit advances. Bear in mind, however, that projected earnings increases may tell an overly optimistic story, particularly with financial companies, as mark-to-market writedowns are typically not included in forecasts.

Onus Now on the Bears

While we believe we haven't performed enough penance to atone for the sins of subprime, we don't tell the market how far it has to fall; it, after the fact, tells us how far it has fallen. Technically speaking, therefore, we believe the onus is now on the bears to prove the 1270 level of the S&P 500—which was reached on an intraday basis on Jan. 23 and successfully retested on Mar. 10, in our opinion—will not hold and we will eventually break below 1250 and thereby enter into a new bear market. What's more, investor sentiment is extremely negative, which we find to be a typically reliable indicator of major market bottoms.

Historically, the correction of 2007-08 is shaping up similarly to the mini-bear market of 1990. Not only did the S&P 500 and U.S. economy peak within two months of each other this time as last, but the 19.9% decline in 1990 is close to the 18.6% correction experienced from Oct. 9, 2007 through Mar. 10, 2008. Also, while the S&P 500 declined 13.7% six months after the Fed started cutting rates in 1990—one of only five times since 1945 that the S&P 500 was not higher six months after the Fed began an easing cycle—the S&P 500 was off 13.2% six months after the Fed started cutting rates back in September, 2007.

While we have been comfortable advising investors to fight the Fed (i.e., expect market declines in the wake of rate cuts) in the near term, we are not so confident it will be the correct advice longer term.

Stovall is chief investment strategist for Standard & Poor's Equity Research Services .