• The VIX is over 50 for the 5^th consecutive day. We broke 75 for the first time on Friday. It is increasing on the daily chart. As a point of reference, in 1987 the VXO was over 75 for 9 straight days, followed by 8 days at over 50. As a relative point of interest, the Oct 1987 crash was 172 on the VXO.
• The TED spread rose steadily all week, and closed at an all time high of ~4.60 .
• We had historical volume yesterday 10/10. The week of 9/15-9/19 also had historical volume for the week, that was an options expiration week. We had the first intraday 1000 point DOW swing in history. 1000 points means we are now in range of a circuit breaker in this low confidence environment. Many of these large scale metrics are continuing to move in the wrong direction and are even accelerating. There is a growing possibility with options expiration being next week, that the worst hasn’t happened yet.

A quick comparative of 2000-2002 to 2007 – present . SP500 Year 2000-2002 . Top to bottom – 25 months

• High 9/1/2000 . 1530
• Downwave Wave 1 – 12/21/2000 . 1254
• Rebound 1 – 1/31/2001 . 1383 +129 . +10.3% . 49% retracement
• Downwave Wave 2 – 3/22/2001 . 1081
• Rebound 2 – 4/19/2001 . 1253 + 172 . + 15.9% 100% retracement
• Downwave Wave 3 – 9/21/2001 . 944 (A year + 20 days = 38.3% retracement from the high. Can’t make this up!)
• Rebound 3 – 1/9/2002 . 1174 + 230 . + 24.3% 74% retracement
• Downwave 4 – 7/24/2008 . 775
• Rebound 4 – 8/22/2002 . 965 +190 . + 24.5 % . 48 % retracement
• Downwave 5 – 10/22/2002 . 768 (which looks to be a retest of the July 24/2002 previous low.)

SP500 Year 2007-Present . Top to bottom currently 12 months. (less than halfway through the time period of the previous decline)

• 2007 High 10/11/2007 . 1576
• Downwave Wave 1 – 3/17/2008 . 1256
• Rebound 1 – 5/19/2008 . 1440 +184 . +14.6% . 58% retracement
• Downwave Wave 2 – 7/15/2008 . 1200
• Rebound 2 – 8/11/2008 . 1314 +114 . +9.5% . 47.5% retracement
• Downwave 3 – In progress… Note the markets high was a year ago. In 2000 down wave 3 ended a little over a year later with a 38.2% retracement.

…

Yesterday – 10/10/2008 – SP500 – Low of 839.80 . +97 point upswing in 45 minutes… 11.6% gain… keep that in perspeective as to where the top of this next current leg may be in the weeks ahead if this turns out to be a short term bottom. The last major high was August 11 and we were at 1313. A 50% retracement puts us at 1076. +236 off the 839.8 low. or a gain of 28.1% that falls in line with some of the major moves of the 2000-2002 SP500 decline which was 230 points in wave 3. The parallels are potentially very similar. As clearly seen yesterday on 10/10/2008, most investors are not going to catch the full measure of any major upswing, especially if they are part of intraday moves, both to the up and down side. The short term bounces above look enticing, but bear market counter trend rallies are especially difficult to play. Most investors will not catch ‘the meat’ of the move, but only a fraction, and that is if they are light on their feet.

*** IN A BEAR MARKET, TECHNICALS TRUMP FUNDAMENTALS. *** THIS IS RULE 1.

Value Stocks- This is the world’s biggest value trap. Most companies have fallen through 5/10 year support levels with increasing volume. Their charts are broken. Any rally or pop is met by investors simply trying to sell into strength in hopes of breaking even, and the old floor which stood for 5 or 10 years will become a difficult ceiling to overcome in this still deleveraging environment which will take months to play out in full. The decline in 2000-2002 took 25 months. It eventually leveled off, but anyone who bought at this stage of the correction, was far too early and took years to make their money back. A 6% dividend yield at a five year high, doesn’t help the owner of a stock that continues to fall another 33-50% over the next year. Investors who are seeking healthy yields will turn to fixed instruments, which do not risk depreciation of their principal. As for the eventual recovery? Take a look at historical examples of how moderate or slow that process can be. Many companies ‘at the bottom’ will sell for current price/book, even price/sales ratios of less than 1. I can pull dozens of examples from 2002 across various sectors, companies who were still great, but no longer making record profits, and had no intermediate term growth prospects. We are not there yet… For value investors- this is not the bottom. It will be months down the road as this forced deleveraging continues it’s course, the economy searches for a foreseeable bottom of the now global wide recession, and this news driven market will create plenty of traps for early longs who think the bottom is in based on any valuation metric. In a recessionary environment with no firm end in sight, investors flee to quality, horde cash, and pay down debts. There are relatively fewer people behind you to prop up the stock price, and even less waiting to bid up that price, no matter what its fundamentals.

The earnings trough- Most companies on a trailing P/E or PEG ratio look cheap right now. It is because it is still early, these earnings numbers may well decline. They have not hit their earnings trough yet.  When the companies are in their trough, the E in the equation drops, sometimes dramatically leading to exponential PE ratios (which makes a stock ‘look’ expensive by these metrics.)  If trailing earnings are negative, the PE will be negative. Most cyclical and high dividend companies will fall into this pattern. Future P/E for many companies, is still to be determined. Many have to mark down estimates in the months ahead if this credit freeze even indirectly impacts their business. For dividend payers- monitor the company’s cash flow which is where dividends are paid from. As long as cash flows remain adequate and the pay out ratio can be maintained, the dividend should remain safe.  GE having to merely maintain its dividend, make a $10B secondary offering, plus an infusion from Buffett, was a giant red flag to future near term expected cash flow.

Cyclical stocks – Long term Investors – Some examples of cyclical value traps (metals/others). AA, PCU, X , POT. These are best viewed through long term linear charts. At the bottom, these companies will not be making any foreseeable profits. Allow the moves the time to finish in the months ahead…

• AA chart
  
• PCU chart
  
• X chart
  
• POT chart
  

*** What we are watching is the end of the game plan of – borrow short, buy long. This is why a lot of these high dividend stocks are being dumped. Normally, they provide a great (and relatively safe) ‘spread’. This is an easy game when times are good, but when there is a major flight to quality, and people have to de-lever they have to dump the investment, even though it pains them and it’s attractive on a fundamental basis. The US dollar in this time of crisis for the foreseeable future should continue to strengthen, increasing its relative purchasing power. This will devalue assets denominated in dollars, including all the hard assets, commodities, as well as stocks… Until there is a light at the end of the tunnel for a firm economic rebound, in which the US with its firming dollar must lead the world out of, the game plan should remain – cash is king.

Some general thoughts…

• This is the 4th consecutive day that the VIX(VXO) has exceeded 50. In October 1987 the VXO was over 75 for 8 consecutive days, followed by 9 days at over 50 . 17 consecutive days. We are at day 4 and we just broke 60 for the first time late today.

• The TED Spread’s lack of immediate reaction to the global rate cut was telling. Preservation in the face of unknown risk is prevalent.
• At this point any rally will be violent as people try to simply break even at best. Many stocks had broken 5/10 year trends the last few weeks and confirmed them. Others had prior, and others yet, still have not. CSCO, EMC, INTC all sold for a fraction of their then current price to book in the summer of 2002 when the market had bottomed. They still were great companies, but the record revenues were gone, and the economy was in recession. And most importantly for a bear market when it eventually hits bottom… There Is No Reason To Buy The Stock… There isn’t a desperate line of people waiting behind you to resell to at a higher price. That’s as far they can go. Today’s tech high fliers will all go the same route, as impossible as that may still seem. This downtrend won’t end tomorrow or this week, or month, we will have violent counter trend rallies. The major ones this year were ~ 14% from the lows to the next short term high, making it even more difficult was that many of them were hidden among intraday moves as well, that show up as tails on daily candles. That 14% is also comparative to the SP500 decline from 2000-2002, so it serves as decent ball estimate. Every piece of news is going to be psychoanalyzed by people looking for a permanent rebound and there will be plenty of traps for longs who get in early to ‘invest’.
• For long term investors, there is no need to rush. The market is not going to run away. It’s time to be patient. The NASDAQ 2000 peak is a good example of how slow the eventual recovery of lost ground can be. There will be plenty of opportunities for investors when the dust settles.