We have yet to hear a persuasive argument about why stocks have now entered a great new bull market that will take them to new highs within a few years. Yes, anything is possible, but most of the bullish “analysis” we hear is something along these lines:
“Stocks lead the economy, and the economy’s recovering, so stocks are going to keep going up.”
The counter-arguments, meanwhile, are actually persuasive:
- Stocks are now back at fair value. Anyone who tells you this is the “opportunity of the century” because stocks are 40% off their highs either doesn’t know what he or she is talking about or is selling something (or both). Stocks are now in line with their long-term valuation trends of about 15X a cyclically adjusted price-earnings ratio (900 or so on the S&P 500–see Robert Shiller’s chart above). This doesn’t mean stocks can’t suddenly get super-expensive again, the way they were in 2000 and 2007. But we haven’t heard a persuasive argument about why they will.
- Recoveries from asset-deflation busts like this generally take decades, not a year or two. The post-bubble busts are usually characterised by slower than average growth and lower-than-average valuation multiples. See Japan and the 1930s. See technology stocks now versus the late 1990s. See gold since 1980. And see John Hussman’s chart below.
- Our debt overhang, increasing government regulation, increasing taxes, and increasing saving will likely keep a lid on economic and profit growth for a decade or more. Stock multiples should eventually price that in, probably by remaining below average for years. Right now, they’re average, not below average.
If you have a compelling argument about why stocks will now get a lot more expensive and stay there and/or why the economy will grow at a faster than average rate for the next decade, we’d love to hear it.
In the meantime, here’s fund manager John Hussman, who comes to the same conclusion that we have:
Even if we have observed the ultimate lows of this downturn (which I would not take as given), it does not follow that the decline we’ve observed over the past 18 months will be progressively recovered without a great deal of intervening difficulty. The S&P 500 has retraced just over 25% of its bear market loss. The 904 level on the S&P 500 was a 25% retracement, and 977 would be a 1/3 retracement, which is not unreasonable. Aside from such retracements, the idea of a “V-shaped” recovery in the market is strongly odds with “post-crash” market behaviour, which generally features a long and drawn-out flat period for years afterward. Given the enormous overhang of Alt-A and option-ARM resets scheduled to begin later this year, extending into 2012, such a profile would not be surprising in the present case.
To put the current downturn into similar context, the chart below overlays several historical crashes, with the time scale measured in months. The downturns include the Great Depression (purple), the Japanese Nikkei index which peaked in 1989 (blue), the gold market which peaked in 1980 (green), and the S&P 500 which peaked in 2007 (red). Thanks to Bill Hester for preparing this overlay.
Note that during all of these downturns, the markets did experience very powerful intervening advances as well (indeed, the rally off of the initial 1929 market crash approached 50% before failing). In each case, however, the fundamentals of the preceding bubble had been broken and it took years for the markets and economy to adjust. In the case of gold, the shift in fundamentals was the end of double-digit inflation. In the other instances, including the present one, the shift was from a steeply leveraged economy to a deleveraging one.
To a great extent, the optimism of investors is based primarily on economic “flow” data (spending, job losses, confidence measures) that remain poor, but have been “less bad” than expected. What concerns me far more, however, is that there is a second and almost equivalent mountain of mortgage resets and probable defaults that will begin later this year and extend into 2012. While our unelected bureaucrats have spent over a trillion dollars to make reckless lenders whole, they have done nothing to materially ease foreclosures or avert the oncoming second wave.
Read John Hussman’s whole column here >
See Also: Grantham: Sorry, We’re Still Screwed
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