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10 Reasons To Be Bullish & 1 BIG Reason To Be Bearish at Trader’s Narrative





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In an attempt to present a balanced view, below are 10 reasons to be bullish and a single (big) reason to be bearish. The bullish case is built by James Altucher, who I consider to be a smart guy. He feels that he is ‘all alone’ in being super bullish. How else would you describe a guy who expects the S&P 500 to rally 50% to reach the previous all time highs?


He outlines his reasons the S&P 500 should hit 1500:

  1. Large Cap US Valuations
    While the general market isn’t cheap, the largest capitalization companies are selling for very compelling valuations. Many have already pointed this out, most prominently Jeremy Grantham’s call for “high quality” US stocks - a notable position for someone who is more inclined towards the bearish camp.

    Also, this weekend’s Barron’s edition had a short article about the valuation skew, going as far as comparing it to the famous “Death of Equities” cover story from the 1980’s. The article included this interesting factoid:

    Oppenheimer strategist Brian Belski recently noted that the gap between the earnings yield on the S&P 500—earnings divided by the index’s value—of 8% is five percentage points above the 3% yield on the 10-year Treasury note. Belski’s research shows that, historically, when the gap has been this wide, the average one-year return on the S&P has been 26.7%. The last time the gap was so wide was in the late 1970s.

    If you’ve been reading the blog recently, that should sound familiar: A Case for Undervalued Equities: Earnings & Interest Rates.

    Forward earnings are looking good and unless they fall off a cliff, the price earnings ratio is looking relatively inexpensive:

    SP500 forward PE Jul 2010

  2. European Sovereign Debt Fears
    As for the major concern of a default or reorganization in the European currency and/or sovereign debt market, Altucher points back to the mass defaults of Latin America in the early 1980’s. I might also point out that a few years after that there was the Savings and Loan financial crisis which was, at the time another major shock to the US economy and lead to very similar soul searching regarding regulation, debt, the lobbying of government agencies and congress (Keating Five) and questions about nurturing “moral hazard”. In the end, the world not only went on, the bull market accelerated.
  3. Unemployment - “Jobless Recovery”
    Altucher says that the labor market has improved for 6 months and that in any case, such hand-wringing over a “jobless recovery” is what we hear at the end of every single recession since the 1960’s. He also believes that this will continue to trend positive.
  4. Corporate Profits
    Since they have not yet started to hire, bringing employment back to normal trends, companies are simply operating as normal with less labor costs. This means that more flows to the bottom line, improving their profit margins.
  5. Hourly Pay
    Altucher also points out that hourly pay has been growing at a rate that makes up for the lack of a robust job recovery. Again, this is following the script from previous recessions where hourly pay growth leads employment gains.
  6. Consumer Spending
    This higher hourly rate has pushed consumer spending to a new high - higher than the last quarter before the start of the recession.
  7. Cash on Balance Sheets
    US corporations are now flush with cash and they will use this eventually. When they do, it will be destined to MnA, share buybacks (which they already have ramped up) or capex. All of these will increase demand and improve the economy and either indirectly or directly translate to higher stock prices going forward.

All these reasons but no one is actually buying! I assume that Altucher is thinking of the buyer strike that has been ongoing for more than a year in retail equity mutual funds. Somebody certainly has been buying since October 2008 when most individual stocks bottomed out.

But the list of worries is myriad, including those listed above and a slowdown in China, fiscal austerity, George W. Bush’s tax cuts lapsing, a “Double Dip”, etc. And I’m sure we can pick apart each and every one of Altucher’s rationales for being bullish.

For valuation we can say it is a mirage; for the European debt crisis we can say it is unprecedented with but the initial stages of contagion; with unemployment and hourly pay stats we can say that they are but part of the picture and point to the staggering duration of unemployment; for cash rich balance sheets we can say it will be used to replenish depleted inventory levels. And for the buyer’s strike, we can say that this is actually a disadvantage because it weakens the market by removing demand.

Remember, the bearish case is always more eloquent and persuasive. It isn’t that difficult to sound intelligent when you’re arguing the bearish side. And it is very difficult to not sound like you’re peddling pie in the sky when you’re arguing for the bullish side.

Volatility and Interest Rates
The above reasons are mostly economic and fundamental logic. Turning our attention to inter-market analysis, I wanted to return to the relationship between interest rates and volatility. Originally this idea was put forward by Don Fishback in 2005 and since then has gained a lot of traction, especially as the relationship has held to a remarkable degree through thick and thin markets:

yield spread compared to volatility offset Jun 2010
Source: Bloomberg

If the relationship continues to hold as it has, the general suggestion is that we are going to see a contraction in volatility and that usually is followed by higher stock prices.

1 BIG Reason to be Bearish
Right now, no one is as bearish as Robert Prechter. Most people will dismiss him for his usually bearish bias or his spotty record. I’m the first to say that he has made some big blunders. But at the same time, it is indisputable that he has had a hot hand for a while now. He not only called the March 2009 low, he also nailed the recent top.

robert prechter Jul 2010

Many readers grumbled rather loudly when I gave him this minuscule platform to share his bearish views a few months ago. Now, the more the market declines, the more prescient that call seems. And that grumbling is looking more and more like an emotional outburst, characteristic of contrarian signals. Prechter has gone super-bearish for one, ultimate reason: deflation.

This is something that concerns me as well because in the end, this is the underlying theme and determinant for this cycle. The deflationary effects of the recent wave of austerity sweeping governments both in the US and Europe is as unmistakable as it is unfathomable, especially when juxtaposed with the lessons of the 1930’s. Here is an excerpt from a recent interview between Robert Prechter and Jim Puplava:

JP: I want to come back to government spending, but first I want to move onto the stock market. In your last two Elliott Wave Theorist issues, you laid out a scenario that would put the Dow and S&P, which in your opinion may have peaked on April 26, as the top from here. You feel that this top is the biggest top formation of all time, a multi-century top and we could head straight down in a six-year collapse that would end in 2016 that could see a substantial portion of the S&P and the Dow wiped out in a similar way that we saw between 1929 and 1933. Let’s talk about that and the reasoning behind it.

RP: Yes, you’re exactly right. I did a lot of work on technical forms, cycle forms and Elliott wave forms in April and May and put them in a double issue. Let’s talk about the cycles first.

The 7¼-year cycle has been quite regular since the first bottom in 1980. The next bottom was at the crash in October 1987. The next one was November 1994, which is when the economy went through four years with lots of layoffs; it was a recessionary period throughout until that cycle bottomed. The next one was between September 2001, which was the 9/11 attack, and the October 2002 bottom. And the latest one was at the low in March 2009. All those periods are 7¼ years apart, so we are in the uptrend portion of the 7¼-year cycle.

However, notice for example that in 1987, the market went up until August of that year and then bottomed in October, just a couple of months later. So the decline occurred very, very late in the cycle. This time it occurred a little bit earlier in the cycle, topping in ‘07 and bottoming in ‘09. In the current cycle, prices should peak the earliest of all of them. It’s what we in the cycle prediction business call “left-hand translation.” The market’s already gone up for about a year, and I think that’s just about enough. I think we’re going to spend most of the cycle going down. But the important thing to note is that the next bottom is due in 2016. That means I think we’re going to have a repeat of what happened between 1930—which was the top of the rally following the 1929 crash—and the July 1932 low. Instead of taking two years, it’s going to take about six years.

It’s going to be a very long decline. It’s going to be interrupted by many, many rallies, just as the decline from 1930 to 1932 was. And every time it bottoms and rallies, people are going to say “OK, that’s enough; it’s over.” But it won’t be over. It’s just going to be a long, long process. I think you and I will probably be talking a few times during this period. One of the interesting aspects of this process is that optimism should actually remain dominant through the first three years of the cycle. That will carry us into 2012. Even though prices will be edging lower, most people are going to think it’s a buy, and you shouldn’t get out of your stocks, and recovery is just around the corner, probably for the next three years. And then, for the final half of the cycle, the final three years, that’s when you’ll get the capitulation phase when everyone finally gives up.

You can get Robert Prechter’s Latest Perspective and read the full report titled “Deadly Bearish Big Picture” (Prechter’s two-part, 20-page, April-May 2010 Theorists) plus his latest June issue with a thorough, new interview on inflation vs. deflation - including his take on gold. Please click here to get the full interview.

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17 Responses to “10 Reasons To Be Bullish & 1 BIG Reason To Be Bearish”  

  1. 1 AB

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    I see two good reasons to want to watch that video.

  2. 2 Babak

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    settle down now… settle down…

  3. 3 TexDenim

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    No one is thinking about earnings, which are just a week away. Not everyone is a bear these days — here’s a quote from today’s NYT:

    But some strategists say the recent sell-off has been overdone.

    “You will see over the next two weeks some strong corporate earnings numbers, and we should have some spectacularly good economic data from Germany and France, partly because of the weak euro,” said Bob Parker, vice chairman for asset management at Credit Suisse. “Markets were focusing on bad news in the last week. My own view is that the chances of a major reversal in China are very low indeed. Yes, it’s slowing, but to 9 percent growth, from 12 percent growth.”

  4. 4 heywally

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    Holy cow, what a crystal ball! I am amazed that anyone could have an accurate prediction that far into the future, given the huge number of variables and the total unknowns of what will happen with International economic policies. Global economic summit with ‘debt forgiveness’ anyone? Anything could happen.

    Fortunately, all one really has to do is use the best methods to just follow price, grabbing the lower/upper middles of the moves. Volatility is our friend.

  5. 5 j'adoube

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    AB looking sideways at a massive double top?

  6. 6 Kristjan

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    Babak,
    One of the people that you follow, namely Mark Hulbert, has compiled a ‘back-test’ using Prechter’s Elliot Wave newsletter advice and came back with some pretty ugly numbers. It’s one thing to ‘nail’ tops and bottoms, which works well for entertainment purposes, but what investors in the real world need is consistency and profits. Investing/trading is not a game where one has to nail the top or bottom as you should probably know by now. Prechter has been calling a top since last summer/autumn. It is interesting that you failed to mention that.

    Please understand that I’m not trying to discredit you, Babak. Your weekly sentiment overview has a pretty good following and people have started to trust you. Bringing Prechter in the game doesn’t do you any good, especially as it is abundantly clear that they only reason Prechter and his EWI crowd get any space on this blog is to generate referral revenue for you. There are a lot of ways to make extra revenue off your blog without sacrificing the integrity of your blog. Please consider this as friendly advice from a fellow trader who, like you, has been studying the ins and outs of market breadth and various technical indicators. If Precther had shown any consistency in the past, I’d be all for him. Quite frankly, I share some of the same fears of deflation that he does, but this doesn’t make me any more inclined to trust his advice, given his track record over the years.

    Two more things to keep in mind:
    1) Compounding is the name of the game
    2) It takes more than x% of growth to come out of a x% decline

  7. 7 AB

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    oh yeah j’adoube, you’re right, a nice double top, better than a head & shoulders…

  8. 8 Garett

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    Babak, thank you very much for your weekly contributions. You are one of three blogs that I check out religiously.

    Prechter from what I can tell didn’t ‘nail’ the bottom, he called for a rally in Feb 09. Also he called for a top in July 09. As pointed out by another commenter his newsletter is rated among the lowest of the low by Mark Hulbert, and this guy also called for the ‘deadly bearish drop’ at the end of 2003.

    I have to to wonder if this Prechter piece is yet another paid space that I see floating around all over the blogosphere. Especially considering your contrarian take that most surely should use Prechter as a ‘contrarian gift from the gods’ like you did Howard Ruff.

    I have read Prechter’s books and newsletters and unfortunately it has lost me a lot of money so count me as possibly being prejudice.

  9. 9 Kristjan

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    It’s quite disappointing to see that you think the people who have taken a look at Precther’s track record need ’settling down’ after they’ve voiced their opinion in a polite and calm manner.

    Babak, you Alexa rank is good enough (120,576 right now) to ditch EWI with their mostly worthless advice about market timing (it is a given that even a broken clock is right twice every day, but no more than that) and substitute that with something that has more value to the readers = brings in more cash. I see that you already have an Amazon affiliate account, so why not feature more books or profile their authors with links to your Amazon page? Or maybe even feature a PayPal ‘donate’ button (for high traffic and good value content, this works, google it if you don’t believe me) or a ‘buy me a coffee’ button? It is not easy to make money with a free blog if you don’t have much traffic. Your site is different - your site has traffic.

    In the end it all comes down to this: do you want the ads on your site to add to the value of your blog or subtract from it? Ino has quite a few useful tools. Amazon is great too, depending on what the client spends his/her money on. But EWI… seriously? Their advice loses people money? Is that what you really want your blog to be associated with? The EWI crowd with their hocus-pocus wave count that only makes money for Precther but not the clients (kind of like GS, isn’t it)?

  10. 10 TexDenim

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    I was a freshman at Yale the same year as Prechter, he lived about two buildings down from me. He was a charming guy, showed no interest in the stock market at the time (I think he wanted to become a psychologist). I didn’t get to know him well.

    I have read his book and briefly subscribed to his materials. He has a fascinating outlook on the world, and sometimes he is eerily correct in his calling of market turns, but I’ve never been able to turn his ideas into tradable concepts. I mean, exactly WHEN do you go short?

    If you followed his advice last March and bought a 200% inverse S&P EFT, you would have about zero equity in that trade right now, because S&P500 went up so much that it would take a huge down move (much more than we’ve seen) just to get back to your original investment given the 200% leverage.

    Prechter is very interesting, but it’s hard to turn his thinking into investment strategy.

  11. 11 ajunta

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    Jeremy Grantham and Andrew Smithers are easily among the smartest professional investors who can clearly show that the current S&P 500 is significantly overvalued. Check out Smithers’ Valuing Wall Street (2000) and Wall Street Revalued (2009) for the best books on the subject of market valuation. Just because the market is currently overvalued does not mean it will go lower. But the only thing that could send it much higher, in my view, is Quantitative Easing II. Until QE II hits, more money can be made shorting. Longer term (2-5 years or perhaps more), gold is the best bet (and blue chips are a good bet if you have a 10-year time horizon), given a truly massive devalution of the dollar (which is what the Fed wants in order to avoid a deflationary spiral) due to unprecedented monetary stimulus along with structural trade deficits and near record debt levels.

  12. 12 Babak

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    Tex, it’s a small world. Prechter wasn’t interested in the stock market until he found the writings of Elliott. And you’re right, he is interested in psychology. His recent attempt to create a new discipline which he’s called socionomics is a cross between (mass or group) psychology and sentiment and economics.

    Although he is the face of EWI and gets a lot of press, doing interviews like this recent NY times one or this Barron’s blog mention, there is a whole team at EWI so what you get from them is not just Prechter’s opinion or take. And it is normal to find the other analysts there disagreeing with Prechter. Anyway, I’m sure everyone is smart enough to decide for themselves. I just think he is on a streak right now and when someone has the hot hand, I pay attention.

  13. 13 thunderbird

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    Babak, I’m starting to see a trend: people who call for doom, gloom, and 900 DJI are all Americans.

    Imagine what the sentiment looks like OUTSIDE of the US (and its puppet state Canada). I’d think the Germans are counting their lucky stars that the Euro has collapsed, making their exports competitive again. China - ooh, only 9% growth this year? Brazil (and most of South America) are probably licking their chops at the secular growth trend for oil, copper, grains, sugar, cattle and pretty much everything else they have an abundance of. Indonesia, Malaysia, India? The same. Southeast Asia must be very happy about the new free trade zone the Chinese are developing. Africa must be happy that the colonial powers are going broke - no more money to fund African race-wars, the threat of peace breaking out everywhere.

    So seriously, what the heck do we have to worry about? The world is decoupling from the US, because the US is a failed empire. But US companies with international competence (JNJ, CAT, and so on) will thrive.

    PS, Socioeconomics is very interesting, wave theory generally is interesting. But not even remotely scientific as of yet. We should lock the socioeconomists in a room with Francis Heylighen, Susan Blackmore and Richard Dawkins for 6 months… a very interesting Theory of Sociological Everything would come out.

  14. 14 thunderbird

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    My point above re: world perspective is that looking at everything from a US standpoint is pretty much the best way to get the wrong picture.

  15. 15 Babak

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    thunderbird, agreed, which is why I ventured into fundamental/economics a few times to write about the dichotomy between the US and other developed countries and the emerging markets I think that is a long term narrative that is slowly unfolding.

  16. 16 thunderbird

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    Agreed, but my point was rather that if you have the interest or time, and language skills, it might be informative to look at commentators from other countries for their opinion (to the extent, of course, that you can find anyone really worth reading - “developing world” often means “delusional psychopath”, e.g. the Russian press).

    If I had the language skills, I’d definitely be searching out intelligent foreign commentators for their opinions. Not American “foreign market desk” people either, but actual foreign residents.

    Even from the socioeconomics perspective, this makes sense - if a public narrative influences market valuation, then you want to look at ALL the public narratives, and not just a particularly depressing one from a country that recognizes down deep that its glory days are long past.

    The one foreign commentator who I have found and do follow is a south American, and he’s pretty bullish on the world economy generally while dismal about the US.

  17. 17 thunderbird

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    Case in point:

    Merrill Lynch strategist David Bianco … also held firm on his 12-month price target of 1,350 for the S&P 500 - almost 30 per cent above current levels.

    Mr. Bianco’s reasoning for his steadfastness is consistent with a theme he has been trumpeting for some time now: That the S&P 500 is a very different animal from the U.S. economy.

    As he pointed out in Merrill’s mid-year strategy briefing last week, the S&P 500 has far more exposure to foreign markets than the U.S. economy does - fully 40 per cent of the index’s profits are derived from operations outside the United States. The index is also over-exposed to commodities relative to the broader economy, which amplifies the influence of overseas demand, particularly from resource-hungry China.

    Meanwhile, the S&P 500 is relatively under-exposed to the biggest area of risk for the U.S. economy - consumer spending. As Mr. Bianco noted, the decision by Merrill’s economists to cut their GDP growth forecasts was driven primarily by a slower outlook for domestic household consumption.

    “Hence, these revisions to U.S. GDP estimates have little impact to our S&P 500 EPS outlook,” he wrote in a report to clients. “And since we had already taken a cautious view on the earnings growth potential at S&P retailers, household durables and auto companies, this slower household spending growth outlook does not threaten our consumer discretionary sector earnings estimates.”

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