Friday, July 31, 2009

This Is a Rally in a Bear Market

One of the most fascinating things about the financial markets this year has been to see the vast majority of the pundits and so-called analysts proclaim the birth of a new bull market.

These pundits can easily be dismissed. They are cheerleaders, market worshippers and perma-bulls who are always singing the only tune they know. They believe that in the long run stocks (and houses too)will come back. True, but will we still be alive?
These same people missed all of the warning signs of the recession, the credit crisis, the housing bust, the stock bear market. They seem to have suffered a 'mental recession'!

I want to visit the question whether the recent low was a once-in-a-generation stock market low or merely a cyclical, short-term low. Ned Davis of Ned Davis Research has identified seven factors to determine if a market low is a secular low, setting up the next long-lasting bull market.

The seven factors identified by Ned Davis are:

1) Money, cheap and amply available
2) Debt structure that's been deflated
3) Large pent-up demand for goods and services
4) Stocks that are clearly cheap
5) Investors who are deeply pessimistic
6) Major investor groups with below average stock holdings
7) Fully oversold, longer-term market conditions

Here are my thoughts on each of these factors:

1) Huge Positive. The Federal Reserve is absolutely flooding the system with trillions of dollars.

2) Negative. The debts that both consumers and businesses has barely been begun to be unwound. Credit market debt load is nearly four times the size of the country's gross domestic product.

3) Neutral. I really don't see much pent-up demand in the US at all.

4) Neutral to Negative. At best, US stocks are at an ok valuation. They were more reasonably valued before the recent large rally.

5) Huge Negative. Most investors I see are dancing in the street that the recession is over and that a new bull market has already begun. Perhaps they should quit listening to CNBC and the like.

6) Neutral to Negative. Most institutional investors' holdings are back to an average weighting historically. However, household holdings of stocks are not close to the low levels seen at the bottom of prior bear markets.

7) Neutral. Some of the excesses of the bubble have been worked off. There are still more excesses to be worked off.

Bottom Line? This is a cyclical bull market or a rally in a long-term bear market, whatever term you prefer.

1 comment:

  1. I would argue that the first point, the availability of cheap money, is a positive for big banks, but it hasn't translated to money availability for individuals and businesses as the banks are sitting on the trillions handed to them. When everyone was spending away, the pundits talked about the consumer engine being 65% of the economy. You don't hear that any more. So what is the engine these days? And yes, no pessimism in this market - quite the contrary. Great post.