Guest post by Azizonomics.
Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.
Sir John Templeton
Buy the fear, sell the greed. Since bottoming-out in 2009 markets have seen an uptrend in equity prices:
Guest post via Dough Short.
In my article Get Ready for the Next Great Bull Market I showed that when the spread between the 50- and 200-month moving average of the S&P forms a trough, it identifies beginnings of major bull markets. Accordingly a new bull market should start at the end of this year. My further analysis, using an adjusted normalized price to earnings ratio, indicates that a major bull market has already started in 2009.
Most of us are familiar with the Shiller cyclically adjusted price to earnings ratio of the S&P. It is the real price of the S&P divided by the average of the real earnings over the preceding 10 years and is identified as P/E10 in Shiller’s S&P data series. The 10 year period seems to have been arbitrarily chosen so as to minimize the effects of business cycles. I am using P/E5 for my analysis, which is the real price of the S&P divided by the average of the real earnings over the preceding 5 years.
From the Shiller data I have calculated the real values of the S&P composite with dividends reinvested (S&P-real), which is shown together with P/E5 in figure 1 below. I did this in order to have all the data in real values, not only P/E5, and since I wanted to compare recent market action with that of the past. One can see that $100 invested in 1873 would have grown over 139 years to about $740,000 by 2012 for a real average annual return of 6.62%.
With the markets in bull mood over the past week, accompanied with crazy Algos, many investors are feeling rather confused. The Euromess is still in play, but with major players, except the algos, we are not expecting a break out either way that will last for long. Here is latest by Hussman of Hussman funds.
I’ve never been very popular in late-stage bull markets. Defending against major losses and achieving our investment objectives over the complete bull-bear market cycle (bull-peak to bull-peak, or bear-trough to bear-trough) requires us to maintain an investment exposure that is essentially proportional to the expected return/risk ratio that is associated with each given set of market conditions. When prevailing market conditions are associated with a sharply negative expected return/risk ratio, as they are at present, and either trend-following measures are negative or several hostile indicator syndromes are in place (what we call Aunt Minnies), we will typically be fully-hedged, and will raise the strike prices of our put options toward the level of the market, in order to defend against steep market losses and indiscriminate selling. At present, we expect an average 10-year total return on the S&P 500 of about 4.7% annually in nominal terms, on the basis of rich normalized valuations. Based on a much broader ensemble of evidence, and considering horizons between 2-weeks and 18-months, we estimate the prospective return/risk ratio of the S&P 500 to be in the most negative 0.6% of all historical observations.
Guest post by Peter Tchir.
How Dumb is Draghi?
The bear case continues to make a lot of sense. We have a global economy that is slowing. Profits are slowing. I see that and generally agree with it. I think housing may be stabilizing more than people give it credit as many of the problems slowly work themselves out, but in general I have no problem with the bear argument, especially for U.S. stocks which have priced in so little bad news relative to stocks in the rest of the world.
The problem I have with the bear scenario is that part of it hinges on Europe failing to respond to Spain. The argument is basically that the EU will fail to help Spain. Spain will continue its collapse and bondholders will lose money dragging down banks and insurance companies. The losses in Spain will scare investors out of Italy, causing the same wave of panic. I think I am more pessimistic than most on what happens if Spain reverts to the Peseta or the Greece exits in a fit of anger.
Some market thoughts by Peter Tchir that has been rather spot on with regards to the market lately.
Lazy and Transitional describes both me and the market. Today I will be extremely lazy and just resend what I sent out Monday.
We are getting very close to my 1,385 “target”. The squeeze is running its course. Investors are still underinvested and I continue to see signs of strength in housing but I’ve been selling into this run up and will continue to sell now as I shift for the next phase of this market.
The next phase will be that the U.S. comes into focus. After a year or more of complaining about why 17 countries can’t accomplish anything quickly, 17 countries will wonder why 1 country can’t get its act together easily. We have ignored the internal politics of the individual countries. We have overreacted to statements from Merkel that aren’t indicative of intent, just pandering to her base. But all of that is slowly receding to the background as we take center stage.
Will the U.S. disappoint or will we somehow get our act together and create policies that are good for this country, and by extension, the entire world?
I am shifting my risk to be ever more specific. Playing the demise of Europe through the S&P 500 has been a bad idea. If you thought Spain was going to be in trouble, you should have shorted Spanish stocks or bonds. I think spending time ensuring that your investment (long or short) actually matches your view will be key. If you like high yield, be long high yield, don’t buy stocks because you think the high yield market will do well. If you like Spain and thing the worst is priced in (as I do for stocks), then buy Spain, not S&P 500.
Guest post by Peter Tchir of TF Market Advisors..
The Only Thing Wrong with the Bear Argument is that it has been Wrong
The bear argument is persuasive. It is well reasoned, makes sense, is supported by fact, yet it hasn’t been working. I was bearish early this year. Too early, but eventually the market did break down from 1,400. Near the end, many bears had capitulated. Many of the most bearish pundits put out “eventually” or “we are right, but maybe not yet” sort of capitulation letters. We haven’t seen that yet, but I think we are getting close. Bearishness seemed to hit its peak (as is typical) after the S&P broker 1,280. Too often we let price action dictate views, and this was a perfect example. Yes, some people were bearish all the way down to 1,280 (I had cut shorts and turned bullish higher than that) but by and large the bear mantra grew after that.
More people jumped on the bandwagon. Some “perma-bears” spent more time trying to recant their prior capitulations than analyzing the market. In any case the bear trade has been painful. We have seen a series of cycles where markets rally on short covering. We hit new levels where the data continues to be weak and shorts get reset as the market stumbles. The bears are nervous but gradually we see some bigger down moves and the shorts fully reset. Then, for whatever reason, something happens that spurs the market to yet another short covering high.
Over the past months, the psychology of the markets has been changing in a way we haven’t seen in many years. The bears, are all convinced that Greece, Spain and the rest of Europe will drag the world into the abyss. We have been rather bearish on the PIIGS situation, but have changed our view during the past month, as we simply have been encountering the shift in psychology in the markets. The crowded trade is being a Euro sceptic. This has proved rather costly during June, especially when it comes to the Spanish equities space. Too many “smart” shorts have entered doomsday short positions, and are now feeling the pain. Although we don’t expect the equities markets to go massively higher in the short term, one shouldn’t rule out a break out to the upside later this autumn. If SPX starts flirting with the old highs, many will start sweating, especially as the “crowd” has abandoned the equities space over the past years. Some more on the tilted psychology via Gresham’s Law.
This can happen in two ways. In the first (and most relevant) instance people can simply overdo the downside and realize that the depths of a depression are not a permanent condition of reality. The second may perhaps come later; as it is – for want of a better word – greed. We expect that the memory of debt-deflation would have to be purged from the mind of the investor before the latter can have a chance of taking hold once more. The world still has a case of ‘2008 on the brain’ / ‘2009 on the mind.
Hussman of Hussman Funds on the anatomy of the Bear….
In the first week of March, the U.S. stock market established a set of conditions placing it among the most negative 2.5% of historical observations (see Warning: A New Who’s Who of Awful Times to Invest) – a short list that includes the major peaks of 1972-73, 1987, 2000, and 2007. Since then, we’ve seen an increasing set of indicator syndromes that are associated with historically hostile market outcomes, maintaining us in a hard-defensive stance that is as rare as it is imperative. Last week, the market reconfirmed the “exhaustion syndrome” that I discussed several months ago (see Goat Rodeo). Prior to 2012, there were 112 weeks in post-war U.S. data where our investment strategy would have encouraged a similarly defensive position with that syndrome in place. Following those instances, the S&P 500 plunged at an average annual rate of -47.5%.
The trend-following components of our market action measures remain negative here, but it is important to note that those components are moderately – probably a small number of positive weeks – away from an improvement that could shift us from such a tightly defensive stance. While our outlook would not become bullish by any means, this shift would rein in the “staggered strike” put option hedges we presently hold in Strategic Growth. These positions (which raise the strike prices on the long-put portion of our hedges) substantially improve performance during market plunges, but make us vulnerable to the loss of put option premium during “risk on” advances such as we saw last week. That is uncomfortable even if the puts only represent a very small percentage of assets (as they do here).
Guest post by Doug Short.
This chart series features an overlay of the Four Bad Bears in U.S. history since the market peak in 1929. They are:
The series includes four versions of the overlay: nominal, real (inflation-adjusted), total-return with dividends reinvested, and real total-return.
The first chart shows the price, excluding dividends for these four historic declines and their aftermath. We are now at 1143 market days from the 2007 peak in the S&P 500. In nominal terms (not adjusting for inflation) over the same elapsed time, the current market is our top performer, 12.7% below its peak. The 1973 Oil Embargo bear is in second at -14.1% with the post-Tech Bubble in third place at -27.1%. The crash of 1929 fared far worse at -65.2%.