1. The rally from March was just returning prices to October 2008 levels following an overreaction to economic conditions.  The new bull market has yet to begin.
2. When adjusted for inflation and the interest rate environment, stocks are at their lowest in terms of price/earnings since 1950, and in the lowest quartile going back to 1870.
3. Extreme inventory and cost-cutting have made U.S. companies more potentially profitable (”profit leverage”) than in a long time.
4. Rally despite “excessive and persistent doubt” about the market and economy suggest that there is not much downside to the market.
5. There is truckloads of liquidity out there.
6. Don’t fight the Fed — with the Fed using unprecedented powers, the market will not be allowed to fall.

I think this is the best thought-out “bull” argument I have seen.  Paulson tempers his argument by saying that there will almost certainly be downtrends and corrections along the way, but now is as good a time as any for a long-term investor to enter the market.

My time to Speculate. I do not disagree with Paulson.  In fact, there are a number of great buying opportunities at today’s levels from a value perspective.  I recently picked up Dun & Bradstreet (DNB) (I will post on this this weekend), for example.  Nevertheless, given the overall continuing economic decline, I believe that we will continue to see plenty of — better priced — buying opportunities for some time to come.

Related posts:

1. Why We Will See S&P 500 666 Again
2. Are Stocks Cheap?

From a buyers perspective, I like this economy.  I am confident that there will be fantastic stock buying opportunities now and for many months to come.  Bear markets are like black Friday for value investors.

Nevertheless, I do not think current market prices are sustainable.  Over the short term, markets can get wildly out of shape — so I will not make any predicitions as to where the market is going on the upside.  We may stop where we stopped today at a little over S&P 500 1000, or may continue to 1,100, 1,200 or 1,500.  There is a lot of money to be made by talented (read: lucky) speculators on the swing up (and down), but for investors the short-term prospects are negative.  Historically, bear markets have always had dramatic rallies off of their lows as resurgent bull market optimism takes a step or two ahead of reality.  They have also retested their lows.

Many people think this time is different — the news media certainly does.  The argument goes that this time is unique because the Fed and Treasury have never bolstered an economy to such extremes before.  Nevertheless, a quick look through the fog reveals the following realities:

• Home prices are still falling.
• GDP is still shrinking.
• The economy is still shedding jobs rapidly.
• Consumers are not spending, and are saving at increasingly high levels.
• Business revenues are not increasing — remaining flat or declining, and nearly all of the reported profits have been through cost cutting.

So if people’s houses are worth less (no equity), our overall economy is still shrinking, people are losing or are afraid to lose their jobs, are therefore not spending, and companies are in turn not making more money — how is the recession over, or even “bottoming out”?

I’m particularly troubled by the GDP numbers released last week that were hyped as being “better-than-expected” with the economy losing 1% in the 2nd quarter vice 1.5%.  First, things are still shrinking.  Second, there was also a historical revision for the first quarter numbers, which means things were overall worse than we thought they were.  As Karl Denninger points out at market-ticker.org, the adjusted GDP decline was really 1.9% when accounted for the historical changes, and when looking at only the private sector — the non-government portion of the economy declined at a higher rate than the 1st quarter at an adjusted 6.46%.  That’s right; negative 6.46% GDP for the portion of the economy that matters.

Reality will eventually catch up with Wall Street, and when it does, it will be very painful for most investors.  There are also several potential crises on the horizon that could trigger the reality-check:

• Commercial real estate and credit card defaults have been largely ignored, but they are likely to start showing up in a big way on most banks’ balance sheets in the third quarter.  There is a growing body of evidence that this is an enormous problem.
• A recent New York Times article suggested that AIG’s core insurance business could be very unhealthy, another collapse here could cause a full repeat of last year.
• There is growing talk about how ill-advised China’s stimulus efforts have been.  While the Chinese economy is growing as if nothing had ever happened and partly masking our own problems at home, the growth does not seem sustainable.  China is essentially giving away money to anyone willing to take it, and China’s large state banks — already overburdened by hundreds of billions in bad loans — will probably not be able to take the inevitable defaults.
• Oil speculation could drive prices high enough (already at $71/barrel with record high inventories and low demand) to convince Wall Street that consumers will continue cutting back to make room for gas (probably to look for jobs, not to go to work).

However the reality-check comes, it will probably come fast.  I wish it were not so, but we will likely see S&P 666 again unless people start spending by the bucket.  The good news is, there will be even more fantastic opportunities for value investors when that time comes.

No related posts.