Unrelenting Bullishness

MarketWatch, the Wall Street Journal, Hussman, MSNBC, and Barron's are all bullish on the stock market. That is pretty amazing optimism in the face of the collapse we have seen. Is such optimism warranted? Let's take a look and see.

The Wall Street Journal is reporting Stocks Look Cheap World-Wide.

World-wide, stock valuations have fallen to a level roughly equivalent to the one that prevailed during the 1970s, according to Citigroup. As of Thursday, global stocks were trading at roughly 10.3 times their earnings for the previous 12 months, even lower than the average of 11.4 through the 1970s.

The selloff has been especially savage in emerging markets. Earlier this week, investors drove down stocks in such markets to valuations that were almost as low as those during the nadir of the Asian crisis in the late 1990s, according to a Merrill Lynch report.

"There are a host of things that have sold off to extraordinarily ridiculous levels," says Uri Landesman, a senior portfolio manager at ING Investment Management in New York. "The baby and all its diapers and onesies were thrown out with the bathwater."

Indian shares, which last September traded at about 25 times the previous 12 months' earnings, now trade at just over 10 times, using Citigroup and MSCI figures. Shares of Chinese companies open to foreign investors are down to about nine times, from 27 times. And Russian shares are trading at about 4.4 times prior earnings, from 13 times.

"Everything looks cheap," says Ronald Frashure, co-chief investment officer of Acadian Asset Management in Boston. That is, "unless the world is going into something like the Great Depression, and we think there's a low probability of that occurring."

Historically Cheap Amid Volatility

MSNBC is reporting Stocks seen as historically cheap amid volatility.

Analysts and money managers agree that unusually sharp volatility and a freeze in credit markets have made it more difficult than ever to forecast a market bottom.

But many of them also say it's clear that stocks are a bargain at current prices, and poised to climb over the long run, even if they zigzag short-term. If third-quarter earnings end up coming in below Wall Street's expectations, some analysts still see room for stocks to gain.

"Any way you slice it, stocks will be either extremely cheap, or cheap, or just average," said Art Hogan, chief market strategist at Jefferies & Co.

The high price of panic

MarketWatch warns about The high price of panic.

If you didn't see the market's meltdown coming, you have plenty of company. If you're selling now, it's probably too late. For a longer-term, retirement-focused shareholder -- and that's most of us -- selling stocks just because they could fall further not only locks in losses, but also makes it less likely that you'll participate in powerful market rallies. Missing those days can be hazardous to your wealth.

Hazardous To Your Wealth

It is stunning how ass backwards MarketWatch has things. Participating in those rallies is what is hazardous for your health because the biggest rallies are in bear markets. There were two 10% rallies in October yet the month finished down 15%. Any long term investor who caught both of them lost money.

A Sunnier Season

The cover story of Barron's is called A Sunnier Season.

IT MUST REALLY TAKE A LOT TO SCARE AMERICA'S money managers. The Dow Jones Industrial Average is down by 30%. Credit is near-impossible to get. A global recession looms, and the cost to clean up Wall Street's mess is climbing into the trillions. And yet, against these odds, 50% of the investment pros responding to our latest Big Money poll say they're bullish or very bullish about the stock market's prospects through the middle of next year.

Barron's latest Big Money poll reveals unrelenting bullishness among many money managers, despite their pronostications for a "contagious" recession and punk profits through 2009.

NOW THAT STOCKS HAVE tumbled to five-year lows, 62% of Big Money respondents say they're undervalued, up from 55% last spring. A scant 7% think equities are overvalued at today's levels. Almost 70% say stocks will be the best-performing asset class in 2009, compared with 13% who favor cash, and 11% who prefer bonds.

"A lot of money is on the sidelines," says David C. Hartzell, founder of Cornell Capital Management in Buffalo, N.Y., which handles about $50 million. "But if you're a money manager, you can't afford to be out of the market, because you might miss the comeback."

Sideline Cash Nonsense

There's that sideline cash nonsense again. Sideline cash does not come into the market except at IPO time and secondary offerings. Otherwise there is a seller for every buyer. If someone buys $50 million of Microsoft with "sideline cash" someone else will have $50 million in "sideline cash" to buy stocks with. I remain amazed at the number of people who manage money that do not know how the stock market even works.

Reasonably Undervalued

In Risk Management and Hooke's Law Hussman makes a case for gradually building an investment exposure.

Though I continue to view stocks as reasonably undervalued, I'm a bit concerned that so many investors appear to be looking for a bottom. The S&P 500 currently reflects the best valuations since the 1990 bear market low. We aren't trying to catch a rally – we are gradually building an investment exposure based on valuations.

My view is that the market is undervalued, that it is priced to deliver attractive long-term returns, and that there is an increasing likelihood of a major bear market advance – but I don't believe that any of this puts a “floor” below the market in the very short term, and I don't believe markets are apt to bottom while everyone is still looking for a bottom.

As an economist, it's clear that the parallels to 1929 are terribly overblown, not least because unlike the Great Depression, governments in this instance have opened a floodgate of liquidity, capital and base money – which they failed to do back then. Even if we were to completely zero out two solid years of earnings for the S&P 500, the fact is that more than 90% of the value of U.S. stocks would reside in the cash flows beyond that point. The main issue for good, established companies here is not the risk to the long-term stream of cash flows, but to what extent the uncertainty about the coming year or two of earnings will frighten investors to sell at depressed prices (thereby pricing stocks to deliver even higher long-term returns).

Of the above articles, only Hussman presented a thorough case worth discussing. That said, I disagree with his thesis. Should the S&P drop to 600 (and I think it will) that is approximately a 40% drop from here. Such a drop is worth avoiding no matter how many 10% rallies there are along the way.

I laid my thesis for the S&P falling to 600 or lower in S&P 500 Crash Count Compared To Nikkei Index. Here is the pertinent snip about fundamentals, see the article for the technicals.

S&P 500 Fundamentals

• The period from 2003 to 2008 was the biggest credit bubble in history, not just in the US but worldwide. It is unrealistic to expect the bust to be anything other than the biggest credit bust in history.
• Unemployment is 6.1% and rising. My unemployment target is 8% for 2009 and continuing higher into 2010.Think what rising unemployment will do to foreclosures, defaults on credit cards, bankruptcies, commercial real estate, and corporate earnings.
• Banks and brokerages made immense profits being leveraged 30-1 to 50-1. However, brokerages are now under control of the Fed. Leverage is still unwinding and will be lowered to 10-1 or possibly lower. Reduced leveraged means less risk, but also reduced lower profit opportunity.
• Boomers are heading into retirement, and a portion of their retirement plan (rising home prices) has been wiped out. Another portion of boomer retirement plans are being wiped out in the stock market crash.
• As a result of the above, those boomers will be doing less spending and more savings. Don't expect retail sales or store profits to come soaring back anytime soon.
• Peak Credit has been reached and a secular shift to frugality and risk aversion has begun.
• Stock markets returning from extreme conditions do not just drop to the trendline, they overshoot it.
• Children who have seen their parents wiped out in bankruptcy or foreclosed on are going to have a completely different attitude towards debt than their reckless parents did. Expect to see more frugality from parents and their children alike.
  

It is impossible to predict the future of course, but fundamentally as well as technically there is every reason to believe lower lows are coming, and the rebound off those lows will be anemic compared to past recoveries. Those looking for an L shaped recession are likely looking the right direction.

With so much "Unrelenting Bullishness" in the face of deteriorating economic conditions and a global economy that is clearly in recession, I simply do not see the earnings projections for 2009 holding up. Nor do I see bullish market psychology coming back.

And while there may not be another great depression, the similarities between 2008 and 1929 are massive. Inquiring minds may wish to review a Crash Course For Bernanke for a comparison.

A massive secular shift in time preference away from risk is now underway. That pendulum has a long way to go before it hits an opposite extreme in the other direction. In my view, bulls are missing the implications of this secular shift.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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