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WHAT THE MARKET WANTS: Jan. 2009

January 5, 2009 5:30 PM   Happily, we can finally report a very positive month in which most of the major indices were up more than 4%. Small-cap Value led the way at 5.8%, and only the bellwether Dow failed to produce a gain (it lost just 0.6%).

Performance was inversely proportional to size. Small-caps gained 5.5%, mid-caps, about 4%, and large-caps, a little over 1%. Even micro-caps, which have been relatively shunned by the market over the past six to nine months, produced a gain of over 4%.

However, at this point, we do not know whether we have a bear trap rally in a secular bear market or have finally started a true recovery. Just keep in mind that for the quarter, all styles and caps are down more than 20%; for the trailing 6 months, down about 30%; and for the trailing 12 months, down nearly 40%. The decline has been both long and deep, and one good month does not necessarily mean the end of Mr. Bear.

January should be a key test. It is traditionally a positive month, particularly among small-cap stocks. However, starting early this month, public companies will release -- day after day after day -- what will very likely be dismal earnings reports. Dismal reports will certainly not be a surprise, so it is the forward guidance from these companies that should command our attention.

Most important to the recovery is the return of consumer confidence. President-elect Obama has proposed unprecedented massive stimulus programs, and he has been joined by many global leaders proposing their own stimulus programs. How long will such programs take to regenerate confidence in the consumer? It could be that the proposed tax relief program (which still must be passed by Congress), along with promised health insurance cost reductions and significantly lower oil prices, will add up to improved consumer spending late in the first quarter or at some point in the second or third quarter. The big question is when!

The market historically has looked at least six to nine months in advance, so it is possible that we’ve seen the worst of this severe market decline. However, labor statistics, particularly those reported early in January, will most likely be shockingly poor and could cause a retest of market lows. Moreover, the conflict in Gaza could conceivably result in expanded political pressures throughout the Middle East and the resumption of spiraling oil prices. The market behavior will likely be somewhere between these two optimistic and pessimistic notions, and in my opinion, we are more likely to see a slow, fitful, but overall steady recovery in market prices throughout 2009.

Clearly, one should invest with caution at this point and not commit entire portfolios to equities too soon. But valuations are at historically low levels, as are yields on fixed income and other secure investments, and cash on the sideline is at historically high levels. These factors have created a bargain-hunting atmosphere where attractive portfolios can be built, which should eventually generate substantial returns. It is the history of bear markets, but no one knows just when one ends. There are no closing or opening bells!

At this point, the best hunting grounds would seem to be small-cap stocks in the Energy and Industrial sectors -- and possibly in the Materials sector, which has been significantly oversold since September. Larger cap stocks in the Health Care and Telecom sectors also remain attractive.

Obviously, timing is key, and none of us have a crystal ball. Patience -- and prudence -- will be the order of the day.

Happy hunting,

David Brown


Next update:  First week in February.