Is the Market Bottoming Out?

01/26/2009 11:37 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says that the market appears ready to retest its November lows, but he thinks we may have a buy signal by midyear.

Is a retest of the November 20th lows in the offing? It certainly appears that we are heading that way.

The Philadelphia Bank Index (BKX) has been ahead of the market since February of 2007 when it topped out. While the Standard & Poor’s 500 index was making new highs in July of that year, the Bank Index was heading south. The Bank Index has continually been breaking to new lows ahead of the S&P, and the fact that it closed at still another multiyear low recently today would suggest that a retest of the November lows is indeed in the offing.

With loan losses much worse than originally anticipated, several major banks have once again come under intense selling pressure. Goldman Sachs expects losses from residential mortgages of around $1.1 trillion, versus an earlier estimate of $780 billion. This does not count losses from credit cards, commercial real estate, and auto loans, which, according to Goldman would represent another trillion dollars.

One positive development that has occurred since the government began injecting funds into the banks is the fact that the three-month LIBOR (London Interbank Offered Rate) has dropped to 1.09%. The LIBOR is a daily reference rate based on the interest rates at which banks borrow unsecured funds from banks in the London wholesale money market (or interbank market).

This is a great improvement, since it was at 4.81% on October 10th. At that time, many banks afraid to lend to each other were on the verge of collapse. Another positive for the market is the massive build-up of money market funds. Currently there is $3.8 trillion in money market funds. Retail money market funds had $1.28 trillion in assets while institutional funds had $2.5 trillion.

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Retail money market funds hold roughly 40% of all money market fund assets. This incredible hoard of cash is the fuel that will propel the next bull market once confidence is restored.

While the majority of investors are apprehensive, we do not think that there is all that much downside risk in the market. In our opinion, the major damage has already occurred. Based on the length of the current bear market, which is now in its 15th month, it would not surprise us to see our models flash a buy signal some time before mid-year and possibly within the next four months. If this occurs, we would expect 2009 to turn out to be a winning year.

But there are no guarantees. We don’t have a crystal ball. The decision-making process we use is based on our market indicators for an entry point and on relative strength for stock selection, and both of those are negative at present.

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