Farrell: Market Observations — What's Needed Now is a Little Distance


We had a flash crash.

Then we had a flash rally.

Now we're flashing again to the downside. (Track real time markets here)

I think we should all go away for a few days and give it a rest. I am psychologically burned, but not because of the market. I discovered a buddy of mine has a first cousin who owns Burger Heaven. How could this be? No discounts? But I did celebrate surviving yesterday with a chocolate sundae.

There are priorities after all.

I figure the best thing to do within this crazy, volatile market is to try and get into the balcony and look down from at least a bit of a distance. As I said yesterday, my early mentor, Alan Shaw, often said that markets will correct by 1/3rd to 1/2 of the advance and still have a solid technical pattern. That would imply we could trade between 1020 and 1130 on the S&P 500 average. At this moment the average is at 1131, down a bunch on the day. But it's like the weather on an island; if you don't like it, wait an hour.

Some very smart guys have said that the odds of a recession have risen.


I would agree.

Maybe you would have to handicap this year at a 33% chance of such a setback. Next year the odds might go up. But then again with the Fed determined to provide liquidity , we might avoid such a fate. Virtual 0% interest rates on the short end for two years will bring all rates down. Imagine a 30 year fixed rate mortgage at less than 4%. It could well be if the ten year Treasury were to fall below 2% as I expect will happen soon. Except for the very big fact that a lot of mortgages are under water, most every mortgage could be refinanced with a big boost to the consumer.

Earnings estimates are still too high. But let's say earnings fall back to 2010 levels at about $85. Recessions often see earnings fall 20%. The question is 20% off what? If $100 was legitimate for this year and $112 (the former 2012 consensus) was valid for next year, $85 might be reflective enough of an economy in some distress.

Whatever, let's use $85 and if we do, the market is now 13 times that estimate. Using the "Rule of 20", which is not a rule but more an observation, a 13 multiple is very cheap. The 20 rule observes that the multiple and the inflation rate will add to 20. Depending on what figure you want to use, inflation is around 2%. If I remember correctly, this was first observed and documented by a guy named Morisani who worked for Ed Hyman. Ed, being generous and giving credit where due, called it the Morisani Rule of 20 for years.

If the interest rate on the 10 year Treasury falls below 2% towards maybe 1.5%, or actually, even if it doesn't, the current yield on the S&P 500 at 1.9% is very tempting. Stocks might soon yield more than bonds. That hasn't happened in years. And, as we have been saying for some time, there's a bunch of stocks that yield well more than the 10 year and have been increasing their dividend with consistency for some time. With some 75 million baby-boomers starting to retire and needing income for their retirement, I think this segment of the market is uniquely attractive.

I also like the results of a CNN pollthat shows what I call disgust with Congress at an all time high. Only 41% say their own Congressperson deserves to be re-elected. It's the first drop below 50% ever. 10% more are unsure, so a majority would probably boot their guy out. "Throughout the past two decades, in good times and bad, Americans have liked their own member of Congress despite abysmal ratings for Congress in general", says CNN polling director Keating Holland. Anti-incumbent sentiment is raging. That's good. This group we have has done an unusually poor job.

Anti-Republican sentiment is at an all time high. 59% say they have an unfavorable view of the Republican Party. 47% view the Democrats unfavorably. That, and the disgraceful downgrade of the US credit rating, accompanied by a collapse in the stock market might, please God, spur these guys into action.

I think I'll go get a burger and pretend he's my cousin as well. It might work.

Vincent Farrell, Jr. is chief investment officer at Ticonderoga Securities and a regular contributor to CNBC.