History suggests that when a true market bottom arrives, most investors don't even notice.
Given that, it seems like there are way too many bulls around these days for the equity market to have seen its lows for the year. In fact, in a column I wrote last Tuesday for TheStreet.com's Real Money subscription service, "The Real Contrarian Trade: Sell Financials," I said as much. I noted that several well-known investors recently went public (on Bloomberg Television and in the Wall Street Journal) with bullish views on the signficantly underperforming financial sector (and, in some cases, the overall market), which has been one of the biggest drags on the S&P 500 index in recent months. Not exactly a sign of excessive pessimism.
In "Contrarian Chronicles: It's too Early to Be Bullish," hedge fund manager and MSN Money columnist Bill Fleckenstein makes a similar observation.
If you listen to some prominent market professionals, you might think the worst is over. But the credit/housing bubble is a far bigger mess than the tech-stock bust.
The Sanguinity Chronicles.
That's how I might title this week's column to capture the changing perspective of three once-wary market observers. I respect their views and include them here to update the bull/bear debate I began last week.
Let's begin with money manager Steve Leuthold. I note that he has joined the camp of former bears who are now sanguine, though not downright bullish. He has upped his equity exposure, saying current valuations make it seem less interesting to be bearish.
Similarly, Jim Stack of InvesTech Research appears to be a bit more constructive, which surprised me. His rationale: A decent chunk of gains from the prior bull market has already been surrendered, which he thinks is a notable development. Stack put it this way: "The lesson here is that unless we are in a heart-thumping generational bear market, then over half the damage has likely been done."
He said the recognition of recession -- witness so many headlines -- means we might be well along in the bear market. Having said that, Stack changed his investment stance only a bit, though his verbiage seemed a little friendlier. He isn't actually bullish, as he's written a lot about the housing bubble.
He and Leuthold have joined the Dow Theory Letters' Richard Russell, who is the most optimistic, in leaning toward a constructive view. (Russell's reason is the market action more than anything else and the refusal of the Dow Jones Transportation Average ($DJT) to make a new low thus far).
To reiterate my view: Those who are really bullish, as opposed to being open to a potential bullish resolution, do not completely understand the ramifications of the credit/housing bubble and what the unwinding means.
Doesn't suffer feds gladly
Someone who does grasp the ramifications and remains quite negative is GMO's Jeremy Grantham, who was interviewed in Barron's recently. His beliefs parallel mine and echo points I made in the later chapters of my new book. Grantham commented:
"People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, 'Oh, you mean like 2000 and 2002?' -- when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11.
"The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor's 500 was down 50%, and the Nasdaq -- which was all anyone talked about back then -- went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market."
To which I would just add a point that I have made regularly regarding the difference between the two bubbles: We now have bad debts. The lender has a debt he can't quite collect on. The borrower has a debt he can't service. That is a much different proposition than what we dealt with in the wake of the stock bubble.
Sitting on cash amid credit trash
Another investor with a tremendous track record who thinks the worst has not been seen is Bob Rodriguez of First Pacific Advisors. In a recent Fortune article, he noted that his cash position is now at 42% and that despite looking around, he doesn't see enough compelling investment ideas. As he says in the article, "High interest rates didn't cause a credit crisis, so why should interest-rate cuts solve it?"
Lastly, Justin Mamis of The Mamis Letter recently noted that bear markets typically involve three legs: denial, realization and give-up. It's his view that we may have experienced the first leg but that the second one is yet to come. This realization leg occurs when people comprehend why the market is going down and sell stocks in response. As he points out: "A bear market can't end -- never has -- until denial turns into realization. . . . This is a long process, because the light bulb doesn't come on collectively but gradually. Some are quicker to catch on, or less dumb, than others."
As to the give-up leg, Mamis characterizes it as the culminating phase. So, given that we may have seen only the first leg, his eyes and his words are telling him that the process has a long way to go and stocks have a long way to fall.
3 beauties in waiting?
Of course, that doesn't mean there won't be rallies from time to time or that we won't occasionally see some interesting stocks to buy. Jim Grant, in the latest issue of Grant's Interest Rate Observer, makes a compelling case for PHH Corp. (PHH, news, msgs), United Rentals (URI, news, msgs) and Harman International Industries (HAR, news, msgs).
He noted: "In the case of the three stocks we looked at, we find them attractive only because they are so cheap. They have been through a terrific bear market of their own (as busted-deal stocks), and the rest of the market may or may not follow that downward trajectory. It's on that macro point that I am simply agnostic."
To sum up, I believe the better arguments are made by those folks who see trouble ahead (though it's worth evaluating the comments from those who see it differently). Everyone has different strategies and stances, including those in the bullish camp, who think that the bad news has already been discounted. But to me, that seems virtually impossible.
Couldn't one just as easily also write that there are too many bears for it to be a top? In my personal life, I don't encounter too many people buying stocks or equity funds. I don't know where all these supposed bulls are.
Posted by: Brian | February 17, 2008 at 01:50 PM