Stocks Sinking to Crash Low Signals Worse to Come

Saturday, May 22, 2010
By Paul Martin

By Lynn Thomasson and Rita Nazareth
Bloomberg.com

May 21 (Bloomberg) — Any investor who wants to gauge how serious the stock market’s retreat is need only know the Standard & Poor’s 500 Index has fallen below its low on May 6, when panic selling prompted calls for reform.

The equity index retreated 3.9 percent yesterday in its biggest loss in 14 months, sinking to 1,071.59, and slipped as low as 1,055.90 today. That compares with 1,065.79, the low two weeks ago when $862 billion was wiped out in 20 minutes. The options market benchmark known as the VIX soared 30 percent to 45.79 yesterday, meaning expectations for volatility are the highest in 13 months.

Europe’s debt crisis has pushed the S&P 500 down 12 percent during the past month as concern grew that deficits in Greece, Spain and Portugal will unhinge the global economic recovery. Regulators have proposed six potential causes of the May 6 crash, including losses in exchange-traded funds and an unwillingness to match orders among some electronic traders.

“As far as we know, it’s not a computer error today,” Jerome Dodson, who oversees $4 billion as president of Parnassus Investments in San Francisco, said of yesterday’s slump. “The May 6 flash crash was driven by technical troubles and didn’t reflect any fundamentals. It’s surprising that regular trading would take us down to the same levels as a technical glitch.”

The S&P 500 surged in the final 20 minutes of trading today, posting a 1.5 percent gain to 1,087.69 as of 4 p.m. in New York.

200-Day Average

The decline in U.S. shares deepened yesterday after the June futures contract for the S&P 500 fell below its 200-day average for the first time since July 2009, a bearish sign to traders who base investments on price momentum. More than 550 stocks reached their lowest price in a year yesterday, according to data from U.S. exchanges compiled by Bloomberg. That’s the second-highest level since April 2009.

The chart patterns show concern the U.S. economy may weaken after expanding during the past three quarters. Reports yesterday showed more Americans filed for jobless benefits in the week ended May 15 and the Conference Board’s index of U.S. leading economic indicators unexpectedly declined in April.

“If this begins to bleed into people’s psyches, then it can perpetuate a negative sentiment that could weigh not only further on the index, but begin to impact the real economy,” said Kevin Caron, a market strategist at Stifel Nicolaus & Co. in Florham Park, New Jersey, which oversees about $90 billion.

Ireland, U.S. Debt

The Stoxx Europe 600 Index has fallen 5.7 percent in the past three days after Germany banned some bets against government bonds and financial institutions. Ireland, the U.K. and U.S. will post the largest budget deficits among advanced economies this year, ranging from 11 percent to 12.2 percent of gross domestic product, the Washington-based International Monetary Fund forecast on May 14.

“You can’t just say Europe is deleveraging and the U.S. is safe,” Komal Sri-Kumar, who helps manage about $100 billion as chief global strategist at Los Angeles-based TCW Group Inc., said in a Bloomberg Television interview yesterday. “Are equity valuations justified given the level of debt? The answer is no.”

U.S. stocks are valued at 19.7 times annual earnings from the past 10 years, according to inflation-adjusted data tracked by Yale University Professor Robert Shiller. That compares with the average of 16.4 since 1881.

Options Insurance

Today’s expiration of U.S. May options may heighten price swings as traders close out their positions, said Paul Zemsky of ING Investment Management. The Chicago Board Options Exchange Volatility Index, or VIX, which measures the cost of using options as insurance against declines in the S&P 500, has almost tripled since April 12.

The expiration “definitely contributed to the move today and could continue to increase volatility tomorrow,” Zemsky, who oversees about $50 billion as the New York-based head of asset allocation for ING, said yesterday. “It could cause the market to overshoot more than it normally would.”

While the stock selloff reflects reasonable concern that Europe’s sovereign debt crisis will derail global growth, U.S. corporate earnings and favorable valuations will prevail, said Laszlo Birinyi, the founder of Birinyi Associates Inc. Profits for S&P 500 companies are forecast to increase 17 percent this year, pushing the index’s price to 13.2 times annual income, according to data compiled by Bloomberg.

“I am not of the view that we’re going to go into a 20 percent downdraft,” Birinyi said in a telephone interview yesterday. “We are buying to take advantage of this weakness.”

Buying Opportunity

Billionaire investor Kenneth Fisher also sees the equity plunge as a buying opportunity. The chairman of Fisher Investments Inc., who oversees about $35 billion in Woodside, California, said the U.S. economic recovery will outweigh the debt crisis in Europe.

Gross domestic product in the world’s biggest economy rose at a 3.2 percent annual rate in the first quarter. Consumer spending increased by the most in three years and business investment on new equipment advanced at a 13 percent pace. The economy will grow 3.2 percent to 3.7 percent this year, the Federal Reserve said on May 19.

“If GDP is rising, you don’t have a recession,” said Fisher. “We’re getting the stock market correction that begins to let us put everything behind us and move on to the next leg. This is a bull market.”

That’s not enough to sooth investors still shaken by the May 6 crash, says Thomas Lee, JPMorgan Chase & Co.’s chief U.S. equity strategist. It’s too “cavalier” to assume the economic recovery is in place as China take steps to slow growth and Europe cuts spending to rein in budget deficits, he wrote in a May 20 research report. He forecasts that the S&P 500 will end the year at 1,300.

“People are extremely nervous following the flash crash,” Lee said in a Bloomberg Television interview from New York yesterday. “It’s normally a wall of worry, but this is a mountain.”

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