The fundamentalist in me. (useful for all technicians pa rin.)  

Put the current correction into perspective, this analysis focuses on historical return data. Whether you’re a fundamentalist or a technician, you’ve got to listen to the advice of history.

As the famous Mark Twain wrote: “History doesn’t repeat itself, but it rhymes.”

People have always wanted to ask… has the bottom already ensued? Why are the markets rallying now? Is the 75bps cut of the Fed and the injection of 150 Bil USD by Bush enough? How about the Bond insurers? Wow! The Dow just went up 227 pts awhile ago sending our PSEI markets up. With these questions, let’s just listen to history.

A History Lesson

Reference: JP Morgan Markets Equity Research

(My Summarized Version)

Let’s see the technical factors first:

• Magnitude of developed market correction, with MSCI Europe down 24% from its 52-week high.
• Lower beta of emerging markets relative to developed markets.
• High dispersion of returns. Previous corrections have been relatively uniform across emerging markets in local currency terms. This decline was led by MSCI China.
• Poor technical situation with most emerging markets below their 200-day MVA.

Corrections of this magnitude have historically been proven buying opportunities. The median post-correction 12-month forward return is 35%. We look at the 12-month forward return after a 15% decline over four weeks. The median forward return from this point is 19%.

Markets are now close to fully pricing in a US recession. Investors’ confidence in China’s growth is weaker. There are differences in the pattern of this correction – longer in duration, a lower beta of emerging markets to developed markets, and markets are below their 200-day MVA. The S&P 500 is down 15% from its peak

Forward P/E for MSCI EM is cheaper today than at the low of last year’s correction
The results are encouraging: if a -15% four- week-decline is used as a buy signal, the
median forward return is 22%. The signal only failed in 1997 during the Asian crisis.

1.) From a magnitude standpoint, the S&P500 has fallen 15% since the peak seen on Oct 9, 2007, compared to the historical median fall discounting a recession of 21%. The median fall took 13 months in history, compared to the three-month fall from the latest peak.

2.) The pricing in of a recession typically starts 6 months ahead. We have seen the S&P500 falling from itsrecent peak for about 3 months. Equities typically bottom out before the official end of a recession.

3. P/E multiples generally enter a slowdown at a premium to the long-term moving average. Currently, the S&P500 is trading at a discount instead.

4.) From peak to bottom S&P500 reported earnings fell by a median 14%. In the current cycle, softness in corporate profitability is mainly limited to Financials.
---this is where the 4Q07 Earnings risk ensues!!!

5.) A typical loss in real GDP from peak to bottom amounts to 2% during a recession.
6.) Fed responded by cutting interest rates three months prior to a recession.


Equity performance will continue to be challenging in the very near term, at least this side of the 4Q reporting season.

However, in terms of direction, we would be looking to re-enter the market sometime in 2Q '08, rather than getting more bearish. If the market were to fall an additional 5-10% in the very near term, risk-reward would become supportive of an OW equity stance, in our view.