I’ve made some good money in the strong recovery that began April 4, and you probably have, too. And all along I’ve been saying it’s nothing but a great big wonderful bear market rally.
I must say, I’ve caught myself this week hoping the market would go down just so I can have the satisfaction of being right. But hope is not a strategy. And I’ve been in this game long enough to know that that kind of feeling is a warning sign. It means it’s time to re-examine the contrary case — the bull case — and see if it holds any water.
The central pillar of the bull case is the old maxim “don’t fight the Fed.” After four fed funds rate cuts so far this year, totaling 200 basis points, the bulls argue that Alan Greenspan is deadly serious about stabilizing and stimulating the slowing economy. History shows, they argue, that whenever the Fed has gone on an easing campaign, higher equity prices follow.
The central pillar of my bear case is that the economy is going to get worse — a lot worse. That’s because stimulus isn’t what the economy needs, and merely lowering interest rates won’t help. The economy is in a monetary deflation that incentivizes consumers and investors to hoard cash, and is triggering cascading defaults. Japan is in a similar state, and even four years of zero interest rates hasn’t helped. What’s necessary is an increase in liquidity that will incentivize consumers to spend, and investors to take risks — and to realign the damaged balance between debtors and creditors.
The Fed’s rate cuts so far haven’t accomplished this, and the markets have been unimpressed. Earlier this week I noted that all the broad equity indices had given up all their gains following the Fed’s bolt-from-the-blue rate cut last week. But over the last two days they’ve all moved higher again, with the Dow Jones Industrial Average and the Russell 2000 even making new recovery highs.
The bulls could argue that the markets are hopefully responding to some signs of increasing liquidity just beginning to materialize. The falling price of gold has stabilized, and has risen $10 off its bottom of a month ago. The dollar has weakened ever-so-slightly against foreign exchange. And the long end of the yield curve is finally above the fed funds rate. These are small and preliminary signs, but at least they are pointing in the right direction.
Another pillar of the bull case is another old maxim, “it’s always darkest before the dawn.” When it comes to corporate earnings it’s definitely pitch black. But the bulls are arguing that “markets always turn long before improving earnings are reported.” For example, for semiconductor analyst John Joseph at Salomon Smith Barney, that’s taken the form of upgrading the semiconductor sector on the grounds that “I’ve never seen it so bad, so it can’t possibly get worse.”
The bears could argue back that this is a logically fallacious reason for buying, one that could be restated as “buy precisely because there is no reason to buy.” It’s a fair criticism, revealing the lack of rigor in the bull case. If the rationale is “it’s always darkest before the dawn,” then the bulls need to be able to prove that it is, in fact, darkest right now, and that it won’t get even darker. The only case for that is just to go back to “don’t fight the Fed.” And if that’s the best the bulls can do, then “it’s always darkest” isn’t even really a separate element in the bull case.
The bears can argue that the bulls’ “it’s always darkest” case is just a thin substitute for a better case they don’t dare make — because they can’t say it with a straight face. What they can’t say is that corporate earnings are on the rebound. Instead, all the analysts just keep moving the near-term numbers down a lot, and their long-term numbers down a little. And because those long-term numbers start as a legacy of the over-optimism of the great bull market, they remain high — and so they appear to show that the analysts are predicting strong earnings recoveries. But let’s be honest: if the analysts hadn’t started with higher numbers to begin with, and had to start from scratch instead, we all know perfectly well that they wouldn’t come up with those numbers. Not when “no visibility” are the two most popular words this earnings season.
Yet another pillar of the bull case is investor sentiment. The bulls argue that in March and through the first part of April, investors learned to not just hate stocks, but to profoundly and viscerally despise them. The late-March drop in the seemingly safe Dow was the clincher. There was even a bear on the cover of Time magazine, for goodness sake. What more do you need to know?
The bears don’t have an effective refutation of this element of the bull case. Yes, they can argue that if the economy ends up getting bad enough, investors can and will learn whole new depths of fear and loathing. But at the same time, it is clear to me that the emotional climax of pessimism in early April will make the market lows achieved then an important support level at the very least. If nothing else, on the way down we can be sure that lots of analysts — who downgraded at what they now fear was a bottom — will support the market with a rash of upgrades.
Putting it all together, and weighing all the evidence in the balance, I find some elements of the bull case compelling. But I still stand by my bear market rally view. That’s my story, and I’m sticking to it.
But it’s difficult, because the job of every bear market rally is to convince you that it’s not a bear market rally. And this one is trying hard to do its job. I’m going to let it try, though, and so should you. If you’re a bear, never stop making yourself consider the bull case — every day.
Related article: Alan Greenspan’s Surprise Rate Cut
