The Bull Case
There are a lot of conflicting opinions and data on the direction of the
economy and the markets. Much of the economic data is bearish. Yet much
of market internal data (technical analysis) is bullish. This has
produced lots of short-term angst. Investors and consumers are worried
about job layoffs, poor corporate earnings, declining confidence and
bankruptcies. Yet, to some market prophets this is good news because
things are hitting bottom and will recover by the fourth quarter.
The concerns about economic and market health are real; they are
supported by research data. Yet to many, they also signal that the worst
is here and that means that we will soon face a turnaround. After all,
after a bad storm, the sky clears. After burning more than 500,000
animals, Mad Cow Disease shows signs of containment. And while
many people have stopped eating beef, some advisors suggest that
shorting stocks, such as McDonald's, can make you money. That's
why E.S. Browning, a smart financial writer, penned a column for the
Wall Street Journal titled "Investors Take Sunny View of
Gloomy Economy" (May 7, 2001). To paraphrase an early Bob Dylan
song, "The times are a changin'," and "The times are
Confusing"
I recently spoke about this situation with Michael Cook, the
Director of Quantitative Research at a prominent hedge fund. He
explained the double-talk this way:
-
Good news is Good news
(e.g. Gross Domestic Product (GDP) growth is good)
- Good news is Bad news
(e.g. GDP growth is bad, because the economy is overheating, and the
Fed will need to tighten)
- Bad news is Bad news
(e.g. the economy is slowing, which is bad for profits)
- Bad news is Good news
(e.g. unemployment is up, which means the Fed will need to ease)
Dr. Cook added, "As I write this to you, it becomes clearer to me
that when we say 'good news is good news' the first "good
news" applies to the economy, the second "good news"
applies to the stock market."
A relevant story is told about the legendary J.P. Morgan. Morgan was on
the phone with the CEO of a company he owned, and asked how's business.
The CEO told him it was great, in fact it couldn't get any better! J.P.
got off the phone and started selling the stock. When asked why, he
said: "If it can't get any better, it can only get worse."
Today, the story reads more like this: "Things are bad; they can
only get better."
Here is some of the major fundamental and technical information cited
for being bullish on stocks. In Mad Stock Disease, Part II we'll
look at the Bear Case.
Fundamental Bull
Fourth quarter GDP product grew at two percent--a much better showing
than the one percent, which was expected. So, while the economy is off
its express growth of five percent last year, it is not exactly
derailed and ready for the scrap heap. It only feels that way on a
comparative basis.
Some analysts think that this is the best buying opportunity since 1990.
Consequently, the next 18-24 months should be very bullish. Momentum
will reappear and will move the markets up. $30 billion has been freed
up by nine months of mortgage refinancing.
Since stocks technology stocks have been hit so hard, the contrary
view is that they will, like sleeping vampires, rise from the dead.
This technical measure is sometimes referred to as "market
sentiment." Sentiment is weak, so it is time to start
becoming bullish.
The rise in unemployment is a positive sign because it means that
companies are taking their medicine and paring down variable costs. This
is a sign that the economy is hitting bottom. It also indicates that
attention is being paid to the bottom line. It is a reason for certain
tech stocks to be surging since layoffs usually improve the bottom line.
Of course, it also indicates weak demand.
Unemployment at 4.5 percent is, therefore, not a bad number. Unless you
lose your job! So far, more than 500,000 employees have been let go by
U.S. companies -and more layoffs are expected. This does not include
temporary and freelance workers who are not officially on corporate
payrolls, but make their living providing services to them.
The Fed is continuing to lower interest rates, thus adding liquidity and
providing a stimulus to the markets. So far they have cut a total of
250 basis points (five cuts of 50 points each) in five months. Greenspan
& Co. want to stop the economic downturn and return to economic expansion.
Rate cuts are positive for stocks because they make equity investments
more attractive than other opportunities such as Treasuries, which lose
in attractiveness because they offer lower yields. In the post-war
period, whenever the Fed has cut rates five successive times, equity
markets have gone up about 29 percent.
Congress is going to approve a major tax cut, with a front-loaded $100
billion stimulus that will increase consumer spending, and move the
economy forward. It will lead to improved demand for goods and
services increase corporate hiring, profits and recovery. This
catalyst is equal to one percent of the economy and may be
accomplished as early as October.
The amount of cash on the sidelines sitting in money market funds is
huge. It now stands at 15.8 percent of total market value of the
stocks on the NYSE, the highest level since 1990. The subsequent highest
gain in the Dow Jones Industrials (since 1980) averaged 18.2 percent
whenever money market assets rose above 13.07 percent of Big Board
Capitalization. This suggests a big upside for stocks.
There is no better sentiment of investor pessimism than such a cash
build-up. "Cash is to bull markets what blood is to Dracula."
IE 7
Firefox 2.0
