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Five Things You Need to Know: Is This a Bear Market Yet?


We just hope our portfolio will be better off after the next 10 years than the last 10 years.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Is This a Bear Market Yet?

Is this a bear market yet? Year-to-date the S&P 500 is down more than 9%. The Dow Industrial Average is down more than 8%. And the Nasdaq-100 is down 14.9%.

Going back to the Federal Reserve's first move to "contain" the debt crisis, a lowering of the Discount rate by 50 basis points on August 17 of last year, the S&P 500 is off nearly 8%. And after 225 basis points of easing in the Federal Funds rate dating to Sep. 18 of last year, the performance is even worse with the S&P 500 off 12.4%.

Nevertheless, optimists intent on measuring bull and bear markets based on the nominal returns of the broad indices, and using the arbitrary marker of a 20% decline in stocks, will be able to stake their claim to some wiggle room before the bear has his day. Since the peak on October 9 of last year, the S&P 500 is only off about 15%.

We're not so sure. As the chart below from the third race at Fair Grounds Race Course on Sunday shows, this is not exactly Hoofy's time to shine.

Poor Hoofy, he "hesitated at the start, and was always back." Sounds familiar. Now, if Boo had been running, well...

2. The Bear's Hidden Decade

Where will you be in 10 years? What will you be wearing? More importantly, where will your portfolio be?

We're just asking because 10 years is a long time. In fact, it's probably a little easier to envision where we'll be standing (DMV hovercraft licensing line) and what we'll be wearing (snazzy space suit) 10 years from now than where our portfolio will be (foreclosure). We just hope (Warning: Hope is not a viable investment thesis.) our portfolio will be better off after the next 10 years than the last 10 years.

For many equities investors the last 10 years has been a lost decade. The stats are rather grim. Going back to February 11, 1998, the S&P 500, exclusive of dividends, has returned an average of a little more than 3% a year. A $10,000 investment 10 years ago would be worth a little more than $13,500 today. That's barley better than inflation, and worse than owning 1-3 year Treasuries over the same period while taking far greater risk. Indeed, some bear markets are invisible to the naked eye.

3. Not Your Father's Dow Jones Industrial Average... Literally

One way to work your way out of a bear market is to simply replace the components of your index with better performing companies. This morning Dow Jones said Bank of America (BAC) and Chevron (CVX) will replace Altria (MO) and Honeywell (HON) in the Dow Jones Industrial Average Index, the first changes to the index since 2004.

The decision to replace Altria is due to restructuring that will result in a smaller, more focused company, Dow Jones said. Honeywell is being dumped because it is the smallest of the 30 industrials in terms of revenue and earnings. Altria, formerly Philip Morris, had been in the Dow since 1985. Honeywell, formerly Allied Signal and Allied Chemical & Dye, had been in the Dow since 1925.

The Dow Jones Industrial Average was created by Charles Dow in 1896 and only one company has managed to withstand the test of time in the index... General Electric (GE).

Interestingly, Chevron has been in the Dow a couple of times before, once very briefly as Standard Oil of California, from 1924 to 1925, and then from 1930 to 1999.

Unfortunately, Dow Jones' market timing on Chevron leaves a bit to be desired. Chevron was removed, along with a handful of other companies, on Nov. 1, 1999 to make room for Intel (INTC), Microsoft (MSFT) Home Depot (HD) and SBC Communications, now AT&T (T). Since that time Chevron is up more than 70%, compared to a 14% gain for the Dow Industrial Average itself, and losses of 46%, 31%, 45% and 31% for Intel, Microsoft, Home Depot and AT&T, respectively. Oops!

4. Why Did We Just Notice This?

On Friday Minyan John sent us the following correction to our recent note on certain U.S. retailers accepting now accepting euros as payment for goods. We wrote that East Village Wines, a liquor store on First Avenue here in New York, has begun accepting payments in euros as well as dollars. It's true, East Village Wines does accept euros. The only problem is that the store has been accepting euros for years now, virtually since the currency's inception.

"Hi, Kevin, love your '5 things' column and read it every day. A small detail you might like knowing--the East Village liquor store in the Reuters euro article has been accepting euros for years now, and there's been a sign up in their shop saying so.

We've been going there for 20 years now, buying our hootch. Great guys.

Thanks for everything,
Minyan John"

Apparently, you can't believe anything you read in the papers these days!

The interesting thing about that is not so much the fact the store has been accepting euros for years, but that it only now makes it into papers. That is exactly the point we've been trying to make about social mood driving action, not vice versa. Social mood is why something several years old only now makes it into the press.

5. Happy Anniversary!

It's hard to believe, but the current debt crisis that began as a subprime contained problem is now almost a year old to the day. We looked back in Five Things to a year ago to see what we were talking about at the time.

From Five Things You Need to Know, No. 2., February 9, 2007:

100% Prime Subprime Complacency?

According to Bloomberg, an index of credit-default swaps surged yesterday on news of problems at HSBC and New Century, suggesting the perceived risks of owning low-rated subprime mortgage bonds is rising.

  • The so-called ABX Index, an index used to create swaps based on 20 BBB- rated bonds sold in the second half of 2006 and consisting of home loans to the riskiest borrowers fell 1.7% on Thursday, the lowest since it was created on Jan. 18, Bloomberg said.
  • The ABX index's level means that investors must now pay about $728,000 per year to protect $10 million of bonds against default when using the contracts, the article said.
  • Ok, this is the subprime market. There's a reason high-risk borrowers are, um, high-risk, right?
  • Check out this letter from Minyan "Dale" Griffith:
    "I agree with the idea that the sub-prime is going to cause problems for someone somewhere, but let me be a bit cynical. Seems to me that most of this paper has been sold to Asia - maybe Asian buyers didn't understand they're getting BBB- paper amalgamated into A paper. So they take it on the chin. They take billions and billions of these blows to the chin. They got lots of cash. So who cares back here in the USA? HSBC? Please. Just expressing the other view and the joys of derivatives and global diversification. There will only be small and isolated problems."
  • The problem we have with this "cynical" view is, one, who says it's mostly Asian buyers who have exposure here?, and two, globalization isn't a one way street where risk gets "diversified" away as if by magic.
  • As well, we find it interesting that so many are so willing to toss aside subprime problems as "minor and isolated" in an economy levered so highly to consumption.
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