Is Stock Market Capitulation Over?

By Mark Whistler | October 15, 2008 AAA

Are we having fun yet? The answer for many is "no" as they stand by and helplessly watch their savings decimated in the market. However, there will be a bottom in this whole mess and savvy investors may just very well profit handsomely from some well timed buys. Here, we will examine the larger paradigm of capitulation and then examine the present market for some clues to where and when the bottom will be.

Capitulation Defined
Capitulation means: The act of surrendering or giving up. But there are really two types of capitulation: Trader's capitulation and the analyst's capitulation. Analysts generally define capitulation as a marked downward slide where stocks lose dramatic valuation, while the media only helps fuel the torrid southern slide, enough so that it may be time to evaluate the situation. Traders define capitulation as the point where the risk of seeking more short side outweighs the risk of seeking great buys and it may be time to act. (For more on capitulation, read Panic Selling - Capitulation Or Crash? and What is market capitulation?)

How to Shore Up the Markets
The first thing we'll need is positive comments from the Federal Reserve that indicate some stabilization of global banks. Unfortunately, the real lifeline will come not from the U.S. government buying out banks (although the action would be the catalyst). The true recovery and larger feeling that the bottom is in will surface when the London Intra-Bank Overnight Rate (LIBOR) falls back to reasonable levels, perhaps somewhere in the 2.0-2.5% area. According to the Wall Street Journal, the "British Bankers' Association, three-month U.S. LIBOR fell to 4.7525% from Friday's 4.81875% rate, and the one-month rate fell to 4.56% from 4.5875%." Coincidentally, on Monday, U.S. equity markets were up dramatically. Falling LIBOR rates will indicate banks are feeling some relief and thus, indicate the immediate bottom is in.

Within oil, however, there may be a bounce coming, especially considering recent news that the Energy Information Agency (EIA) slashed 2008 and 2009 global demand forecasts, but may have been misunderstood by Wall Street. As ONG Focus points out, the EIA, "now expects global oil demand to total 86.5M bbls/day this year (meaning demand will be increased by only 0.5% from 2007 - the slowest growth in 15 years) and 87.2M bbls/day next year (which would represent an increase of 0.8% from the demand for this year." It's important to remember that oil has a direct correlation to the U.S. dollar. In theory every 1% the U.S. dollar rises, or falls, oil should gain, or lose, about $4 in premium. What's more, for every 1% global oil demand jumps, or retracts, the price of oil should rally, or fall by about 20%.

The Greenback Too!

In general a lower the U.S. dollar means America's trade balance will narrow, due to the greater ability to export, based on the currency exchange.

With the above in mind, the U.S. will have a difficult time shoring up the trade balance if the U.S. dollar wavers because of global interest rate differentials and an carry trade cash influx towards currencies with higher yields. As much as I hate to say it, in the present environment, a stronger U.S. dollar would only hurt the larger global economic prospects of America.

Case in point, in the October 10, U.S. Trade Balance report, America's trade gap narrowed to -$59.1 billion following the prior month's -$61.3 billion (revised from -$62.2 billion), while the market was expecting a -$59.0 billion reading. Excluding petroleum, however, the trade gap widened, according to RBS Financial Markets. The firm goes on to say, "The Fed's latest statement expressed the expectation that net exports would not be as supportive of growth as it has been in recent quarters. The deterioration of the ex-petroleum balance gives credence to that belief and is likely to reinforce the Fed's concern about faltering U.S. growth."

Lock, stock and barrel, the Fed Funds rate will likely be at 1.00% to 1.25% by the end of this year. (For more on this rate, read FOMC Rate Meeting.)

What This Means To Investors
At the end of the day, as LIBOR rates fall, oil bounces and the U.S. dollar loses a slight bit of strength from present levels, markets will likely regain their legs, at least in the short-term. Larger problems including that of the massive U.S. trade deficit and national debt will both weigh on long-term growth, but at least in the short-term, risk averse investors may very well find some good buys within markets.

If the U.S. Treasury fails to act and LIBOR rates spike again, investors should don their crash helmets. However, if the U.S. Treasury comes through, this will be good news for fundamentally stable companies like Goldman Sachs (NYSE:GS), Proctor & Gamble (NYSE:PG), IBM (NYSE:IBM) 3M (NYSE:MMM), Johnson & Johnson (NYSE:JNJ) and Bristol-Myers Squibb (NYSE:BMY).

Each of the aforementioned companies is trading with a P/E around 10, except Proctor & Gamble, which is 17.6. Regardless, due to the broader market selloff, all are nearing fundamental levels that are attractive for investors who are looking for long-term portfolio stability. What's more, all of the five companies above are profitable, with net income in the billions. It's important to note that there could still be a volatile downside swing left in the market, but for those in for the long haul, the list here could be the cornerstones of almost any portfolio.

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