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:
- 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:
- 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.
- 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.
- 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.
- 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.
- 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.
- 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:
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.
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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