From Whence Might the Black Swan Fly - Market Snapshot - SP500 - 29 August 2011

Index Level

The market closed up strong, 2.83% on the day and up 13.72% over 12 months.  It trades at a 11% discount to intrinsic value and a 30% premium to fair value and these values are calculated by reference to operating earnings, not as reported earnings which tend to come into focus during recessions and severe slowdowns.  Intrinsic value is the value embedded in the security itself; it is calculated by estimating the future income to be generated and retained (generally post tax profit less dividends and share buyback) by the company, and discounting it to the present value. The fair value of a stock is the the estimated future value to be returned to shareholders, via dividends and stock buybacks, discounted to present value.

Market Snapshot - Sensex - 29 August 2011

Index Levels & Performance

Sensex closed at 16,416 up 3.58%, but remained down 8.79% over the past year.  Prices trade at a discount of 13% over the average prices paid by investors over the past 12 months and at a discount of 8% to intrinsic value.  Yet even today prices trade at a 57% premium to fair value.  Intrinsic value is the value embedded in the security itself; it is calculated by estimating the future income to be generated and retained (generally post tax profit less dividends and share buyback) by the company, and discounting it to the present value. The fair value of a stock is the the estimated future value to be returned to shareholders, via dividends and stock buybacks, discounted to present value.

My Age Arrives; for I am Taurus

Today I am unborn. But my time is coming. The worst of the turbulence is over; but it is not yet all done, the skies remain overcast and we need that final storm. After which we will see silence and then I shall storm the world once again; for I am Taurus, and I have been dead 11 long years and I am looking forward to my rebirth.

Are We Seeing a Waterfall Decline in the Markets

During waterfall declines, the market tends to drop from its highs by 24% on average, over a period of 50 calendar days. During the final 21 days of the waterfall declines, the 10 day moving average rises exponentially, with the 10 day moving average doubling from this time, to the end of the waterfall decline.

The most recent peak occurred at 1,353 on 7 July, 2011. Fifty days on would put the tentative bottom date at 26 August, 2011, at a level of 1,025; with the SP500 at 1,199 at present, the potential downside is a further 15%. If this is indeed a waterfall decline, with the markets being 29 days into the decline, we have a further 21 days to go and during this period we should see a sustained increase in volume driving the 10 day moving average upwards. So far, NYSE composite volume bottomed on 21 July, 2011, since then daily volume has risen 264%. Provided high volume is sustained, by late August 2011, we could easily see a doubling of the 10 day moving average over the 10 day moving average on 21 July, 2011.

Does S&P's Downgrade Matter?

SP's downgrade of US makes no difference on the real economy.  In fact, even if SP had created a new quad A category and upgraded US to AAAA, it would not have mattered.

Today US treasuries across the maturity spectrum deliver negative real returns.  The GS10 at decade median levels has yielded real returns of 1.7%.  Ultimately rates will rise towards this level.  And while the SP downgrade may help start the process, it is unlikely to have an enduring impact because the timing of a reversion to median levels depends entirely on other factors.

Are Conditions Ripe for a Rally?

The good news is that the VIX has spiked and the market is very oversold.  The market may fall further and once the VIX comes down to below 24-25 levels we may have a bottom in place.  The question is whether the rally from the bottom is sustainable, or is it a rally to be sold into.

Interest Rates, Inflation Rates & the Index

US
GDP growth rate is in decline (right axis).  Interest rates remain low, spreads between GS10/Baa/Aaa have normalized; that absurdity of falling GS10 while Aaa and Baa rose has vanished.  Interest rates are all largely at 12 month moving averages, over time I expect yields to rise.