Why Are Perma-Bears Coming Out of Hibernation and Recommending We Buy?

Well, aren't you glad October 2008 is over? After all, the 17% drop in the market was the worst month in 21 years (Crash of 1987). Given the tremendous drop in stock prices, we are beginning to read about many perma-bears who have turned bullish, which is quite a good sign for investors (this week's Barron's includes an interview with Steve Leuthold of Leuthold Group, another so-called perma-bear who is bullish on stocks).

First, what is a perma-bear? The nickname has been given to investment strategists and managers who seem to be permanently bearish. Why do they rarely sing the praises of the stock market's prospects? Did they have a bad experience and simply have yet to get over it? Hardly.

Actually, perma-bears do turn bullish every so often, it just takes a lot for that to happen. The reason is because perma-bears typically only want to invest heavily in stocks when prices are extremely cheap, typically in bear markets. You see, outsized market returns are attained the easiest when prices are depressed, so perma-bears are more than willing to forgo owning stocks in size until prices are dirt cheap. As a result, they are not bullish very often because bull markets last far longer than bear markets and economic expansions last far longer than recessions.

Since investing when stocks are dirt cheap is a proven winning strategy, why do perma-bears get so much heat? Well, the simple explanation is because since the first stock market opened for trading, in any given year stocks have risen about 80% of the time. So, if four years out of every five are going to see stock prices go up in value, perma-bear detractors would argue that only investing during the depths of bear markets, while a profitable strategy, misses out on many years of market gains.

Fair criticism? Sure, but it depends on your viewpoint. Proponents of long term investing would argue that one would be better off not trying to time the market and accept that during any five year period, they expect to make money during four years and lose money during one. Statistics have shown that strategy pays off handsomely over the long term.

Perma-bears are a little more difficult to please. They realize that the average bear market results in a 30% loss, and such a hit requires a 43% rise just to get back to where they were before the drop, so they prefer to try and avoid such a painful decline, despite it being temporary in nature. By only investing when stocks are dirt cheap, they are able to reduce the chances they incur sizable losses. As a result, the perma-bears missed much of the last bull market (stocks rose for four straight years heading into 2008, just as market history would have predicted).

So, what should we conclude when the worst month for stocks in 21 years has resulted in several well-known perma-bears coming out of hibernation and recommending investors buy stocks? It means that for the first time in a long time, stocks are at the low end of their historical valuation range, which usually equates to an excellent buying opportunity. The perma-bears are getting another opportunity to come out of hibernation and play, which bodes well for all of us.

Comments

[Smarty_Pants:]

Yes. We have a solid foundation upon which to build a prospering economy.

1) Banks have avoided bankruptcy thanks only to massive transfers of public monies against the will of the majority of the people.
2) Insurance companies are in over their heads with bad derivative products and have yet to recognize the massive losses they represent.
3) Manufacturing concerns are also struggling to stay afloat.
4) 1 in 5 homeowners are upside down on their mortgage.
5) Unemployment is increasing.
6) Government revenues at all levels are decreasing.
7) US debt is already at unthinkable levels, will never be repaid, and is growing faster than ever before.

I don't think conditions for economic growth have ever been more promising.

NOT.

2008 Nov 03 09:48 AM

[ddtuttle:]

None of us has ever been through anything like this. Well, a few 100 year olds maybe. But generally the judgment of experts is useless because they have no experience with this kind of market. In fact, they're sure they can look at the last 30 years of data and see what's going to happen now. But the information you need is not contained in short term historical data. That `makes experts less than useless, and down right dangerous.

The perma-bears have been waiting their whole lives for this. The only problem is they've never been through it. So they dust off their 30% down rule, and start buying. The problem is there is NOTHING fundamental is going up, as listed in the last comment. The market may go up against all odds, but we have a lot more bad news to ripple into earnings before you should start buying. If the market turns back up 6 months before the end of the recession (another piece of trivia that might be useless this time). look for a turn around in June of next year, not now.

2008 Nov 03 02:51 PM