We hope that the market bottomed 5 weeks ago and that it’s straight back to DOW 15,000 from here. And it might be. (Anything’s possible).
That said, we still find the “suckers’ rally” argument far more persuasive than the “new bull market” one. If anyone can make a persuasive case as to the latter, we’d be eager to read (and print) it.
For example, we’ve read–and printed–Jeremy Siegel’s novel argument that the S&P 500 is actually worth 1250 or so, but we just don’t find it persuasive. We like the good old cyclically-adjusted earnings analysis (see Robert Shiller’s spreadsheet below), and that puts fair value at about 900-950.
Using this valuation analysis, stocks are now slightly undervalued. This level of undervaluation is meaningless as a near-term performance indicator, however, so don’t get excited. Also, we think the current asset deflation (house prices, commercial real estate, etc.) is far from over, so we expect to have another plunge into the depths–or at least a long sideways drift–before we’re through.
About the best we can say is that, after 15+ years of overvaluation, stocks are finally priced to produce average returns over the next decade (9%-10% a year or so). Compared to the rate of return on cash, that’s great news.
Fund manager John Hussman lays out a persuasive bear case in this week’s letter. Here’s an excerpt:
We’ve seen a nice bounce to clear an oversold condition, coupled with the very ordinary “ebb and flow” of economic data that periodically offers intermittent relief even in the worst economic downturns. What we haven’t seen to any real extent is “revulsion.” Quite to the contrary, investors have frantically bid up the worst credits – distressed financials, homebuilders, and heavily leveraged cyclicals, while the percentage of bullish investment advisors has quickly surged above the percentage of bearish advisors.
As veteran market observer Richard Russell noted following a tribute Saturday evening, “one question that was asked repeatedly was ‘What is the difference between investors’ sentiment now and that which existed at the 1974 bottom?’ My answer was that there is a lot of complacency today. In fact, many leading analysts are already saying that ‘this is a new bull market.’ … At the 1974 bottom, the sentiment was the opposite — people and funds were black-bearish. Nobody talked about ‘the danger of missing this advance.’ In fact, when I turned bullish in late-1974 I received hate-letters and angry notes saying that ‘Russell, you have lost your mind,’ and ‘Russell, why don’t you hang it up and find a business that you’re fitted for.’ I mean people were furious that I had turned bullish, pretty much the opposite of sentiment today. Actually, I’m surprised to see how quickly analysts and investors are willing to turn bullish today.”
That’s not to rule out the possibility that the final low of the bear market is behind us (though I doubt it). What I do see as unlikely is a “V” bottom where stocks will now proceed to durably recover their losses without (at least) a very difficult and extended sideways period that take stocks back to levels that compete with the prior lows. Historically, advances of the size we’ve observed have only “stuck” when the major indices had already advanced past their 200-day moving averages by the time stocks were about 20% off the lows.
There’s a reason for that. During a true bottoming process, favourable market internals are typically “recruited” even as the market is moving down or sideways. Investors work through the ebb-and-flow of information through repeated cycles of enthusiasm and disappointment. To expect the disappointments to quickly come to an end and to be replaced by clarity is to expect something that is not characteristic of historical experience…
Very simply, new bull markets are generally not widely heralded, and investors should be awfully suspicious when there is a consensus that “the bottom is in.” As I noted back in December, in Recognition, Fear and Revulsion (before the market took a plunge to fresh lows over the next two months):
“Strong intermittent advances are typical during bear markets, and can often achieve gains of 20% as we’ve seen in recent weeks, and sometimes substantially more. But the very existence of bear market rallies can be a problem for investors, because they clear the way for fresh weakness. The scariest declines in bear markets are typically the ones when investors think they are making progress and recovering their losses, only to see stocks go into a new free-fall.
“That cycle of decline, followed by hope, followed by fresh losses, is really what ultimately puts a final low in place. The final decline of a bear market tends to be based on “revulsion” – a growing impatience among investors who conclude that stocks are simply bad investments, that the economy will continue to languish, and that nothing will work to help it recover. Revulsion is not based so much on fear or panic, but instead on despair and disillusionment. In a very real sense, investors abandon stocks at the end of a bear market because stocks have repeatedly proved themselves to be unreliable and disappointing.”
Could the final low of the bear market be in place? Sure. But even if that were the case, it does not follow that the markets will recover their lost ground quickly, and it is particularly dangerous to believe that the major indices will not meaningfully retest (if not substantially break below) the prior lows.
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