rffrydr
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Joined: 30 Oct 2005
Posts: 16939
Location: Sunny California
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 Posted: Wed Mar 11, 2009 8:53 am Post subject: The Law of Small Numbers |
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Something that really bothers me about pure technicians lost in their patterns--they will always say that whatever it is, it's in the numbers. But there comes a point where the very numbers, their absolute value, will stand in the face of any "chart."
| Quote: | Short View: The law of small numbers
By John Authers, Investment editor
Published: March 10 2009 19:30 | Last updated: March 11 2009 02:23
There are strong reasons for the latest sell-off in stocks, but they do not mean that prices must fall uninterruptedly.
The preoccupation at present is with cash, Moody’s is projecting a 15 per cent default rate for high-yield bonds this year, which would be the highest since the Depression year of 1932. Companies facing default are likely to conserve cash by cutting dividends.
Until recently, this had not happened. Dividends per share for S&P 500 stocks rose by 2 per cent last year, in spite of a 28 per cent cut in financials’ dividends. But after the rash of recent cuts, Goldman Sachs estimates a fall of 22 per cent for this year. This would be by far the worst fall for dividends since 1938.
Such an outcome would justify the latest leg down in equity markets. But for all their problems, financial stocks are subject to what might be called the “law of small numbers”. There comes a point where the probabilities point to rallies.
On Friday, when its share price fell below $1, Citigroup was priced at 7 per cent of its book value, down 98.72 per cent from its high, Bloomberg data shows. At this point, the balance of risk and reward from a “short,” or bet on a further fall, looked awful. So it proved.
On Tuesday, the news that Citi expected its “best quarter since 2007” (not a high hurdle) was enough for a 50 per cent rally from Friday’s low. It is still 97.46 per cent below its high, at 11 per cent of its book value. But anyone who sold short when it was below $1 would have lost half their money.
The S&P 500 managed a 6.4 per cent rally on Tuesday, while the S&P financials is up more than 20 per cent from its intra-day low of last week, which would normally qualify it as a bull market. This might yet turn into a bigger rally, in spite of the logic pushing prices down. But for now, it appears to be nothing more than a product of the law of small numbers.
john.authers@ft.com |
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