The Anti-Stock Rhetoric Is Overblown

The market's continued strength over the past two weeks has been very encouraging. For stocks to continue to climb after such a surprisingly weak GDP announcement and during the quasi-hysteria caused by the swine flu news indicates that expectations had gotten so low in the earlier part of this year that stocks did indeed become quite undervalued. Now, any flickers of hope seem to be slowly pulling money back into the market -- and there's a lot of it out there to pull back. According to Forbes, investors have $9.5 trillion in money with zero maturity -- cash sitting in Treasuries or money market accounts. Charles Schwab's Chief Investment Strategist Liz Ann Sonders says that is more than the value of all publicly traded U.S. firms, and represents the most money sitting on the sidelines in history.

Still, even with all that cash laying in wait, many are saying that now is no time to put money into stocks. I disagree, and I thought it would be a good time to counter several of the bearish arguments I've seen recently. Here they are -- with the other side of the story.

"We're Due for a Pullback": Yes, the dramatic turnaround we've seen since March 9 has been a bit dizzying, and makes one wonder whether it was too much too soon. But a closer look shows that it may, in fact, have been just the right amount. According to Kenneth Fisher, one of the gurus upon whose writings I base my Guru Strategy computer models on Validea.com, the nature of bottoms has historically been "V-shaped", meaning that the steeper the decline at the end of a bear market, the steeper the incline at the start of a bull run.

When we look at the current turnaround, the "V-shapedness" is pretty striking. Back on Jan. 12, the S&P 500 sat at 870.26. Over the next eight weeks exactly, it tumbled to that 676.53 March 9 low. As of Friday's close (which was two days shy of exactly eight weeks since the March 9 low) the index was back up to 872.81 -- less than one-third of one percentage point from that Jan. 12 starting point.

Could there be a "post-V" pullback, though? Maybe. But history shows it's no sure thing. Back in 1982, after bottoming following a nasty bear, the market surged 22% in about 40 days. It then had only a minor pullback of a couple percent before surging almost 20% in the next 40 or so days. The bottom line: Trying to avoid a 10% or 15% pullback that might never occur is, for me, too risky a proposition -- especially given that equity prices are still fairly low. Avoid stocks at these valuations, and the odds are you'll be sorry.

"The Great Depression Recovery Took 25 Years": This, frankly, sounds terrifying on the surface. And, in literal terms, it's true that the Dow Jones Industrial Average took about 25 years after its Great Depression bottom to reach its pre-Depression high. Does that mean that it could be 2027 before we get back what we've lost in the recent market crash?

According to Mark Hulbert, founder of Hulbert Financial Digest, that's pretty unlikely. Hulbert said in a recent New York Times column that the 25-year Depression recovery figure is misleading for three big reasons: Deflation, dividends, and the difference between the Dow and "the market" (see this post for more details). When you take all of those factors into account, when did investors really regain the purchasing power they had, pre-Depression? About four-and-a-half years after the 1932 market bottom, Hulbert says. That's just four-and-a-half years to regain the losses suffered when the Dow declined 80%.

"Bonds: The Best Long-Term Investment": A couple of big names -- Rob Arnott of Research Affiliates and Forbes' Gary Shilling -- have made headlines with articles along these lines recently. Shilling and Arnott are both very smart men and are extremely knowledgeable about the financial world, but I -- and many others -- believe their data is somewhat misleading.

Shilling, for example, contends that stocks underperform bonds, even in very bullish periods. In fact, he says, 25-year Treasury bonds generated 11 times the return of the S&P 500 from the early 1980s through March of this year. That may be true, but the problem with Shilling's argument is that the early 1980s was perhaps the greatest period to buy Treasury bonds in history. With inflation rates around 13% or so, T-bonds were offering yields in the 15% range. Today, the rates are in the 3% to 4% range. In addition, to make the stocks/bonds comparison through March of this year means you're valuing stocks just a few weeks after a low that represented the second-largest bear market decline ever. Doesn't seem like a good time to get a "big picture" view of what to expect from stocks in the future.

"Haven't You Heard? Stocks are More Risky in the Long Run" A recent study by two notable professors -- Lubos Pastor of the University of Chicago and the National Bureau of Economic Research and Robert Stambaugh of the University of Pennsylvania's Wharton School -- found that stocks actually become riskier over longer periods of time, contrary to what conventional market wisdom states. The reason lies in the fact that the future gets harder to predict the farther out you go. For example, we have a decent idea of what global warming's impact will be in the next year. But 20 years from now, the picture gets much murkier.

Given all that we've been through in the past year or two, the study injected another level of fear into the stock debate: If stocks just lost more than half their value in a matter of a year-and-a-half, why would anyone want to invest for longer -- and riskier -- periods?

Well, in an interview with one of Wharton's web sites this week, Stambaugh indicated that things weren't that bleak for stocks, and urged readers not to misinterpret what the study meant. The study's findings about volatility increasing over longer periods doesn't mean that volatility in the future will be greater than the high volatility levels we've been experiencing in the past several months, he said: "We expect that sort of short-run volatility to moderate. Our paper is more about what a more typical environment -- or more average environment -- for volatility would offer an investor in terms of short-run versus long-run. We'd all be very surprised if [this historically high short-term volatility] were to continue for long periods".

In addition, Stambaugh said the study only looked at stocks. Other asset classes could get riskier over time as well, he said. "It's quite possible that this same kind of [long-term] uncertainty in nominal bonds could well make them less attractive," he said, adding that he and the study's other authors hope to due follow up research on that issue.

Speculation Doesn't Just Hurt Bulls

Now, to be clear, all of this is not to say that the market's current run is going to continue, uninterrupted, for months and months. What it does mean, however, is that much of the anti-stock rhetoric that is lingering in the post-crash environment seems somewhat overblown, or based on mere speculation about potential disastrous consequences -- and allowing speculation to keep you out of the market can be as dangerous as allowing speculation to pull you into the market. I'd rather continue to look at the facts and the long-term data, and right now I think both are indicating that this is no time for long-term investors to bail on stocks.

Comments

[capital pains:]

Is it a "V" ? Is it a "U" ? Is it a "W" ? How very mundane this article is.
So tired of reading and hearing the herd analysis du jour.
Pullback ? Leg up ? Leg down ? Blah, blah, blah ..What a yawn !

May 03 09:15 AM

[Tony Daltorio:]

Before anyone should "believe" what you say in this article, how about informing your readers about your thoughts on the market in the past?
Were you one of those always bullish Wall street types that has been wrong for the past decade, but is still preaching the same sermon?

May 03 11:12 AM

[Market Sniper:]

The market still has to make its case. Until we surpass the February high, then the January high and then the election high, we have lows beneath lows and the bear market is intact. So far, this is a classic bear market rally. One for the books even. However, to call this the beginning of a new bull market is more than a bit premature.

May 03 01:35 PM

[Coffee Joe:]

The true risk is that Obama is really trying to push an agenda that does not bode well for the economy. I am speaking of the incredibly large deficit that only a $10 TRILLION pump priming can generate. As we tax the poor with high "sin" taxes, exise taxes etc, and obviously there will be new taxes coming along, that $9.5 Trillion will be running to hide from the taxman looking to redistribute this unfair wealth.

May 03 04:15 PM

[Ned S:]

Re the statement "just four-and-a-half years to regain the losses", I'm curious as to whether that applied to the "average" 1929 pre-crash investor? What about the investors who had their money invested in companies that went bankrupt between 1929 and 1932 during the downhill run? (I assume there were some?)

Still, shouldn't be sceptical I suppose - It wouldn't do to see Wall Street deprived of an opportunity to get its claws into too much of that 9.5 trillion that's been parked up.

May 03 06:58 PM

[Michael Shu...:]

John:

C'mon, John, you are one of the smartest men I have met in our business with little ego and a true concern for clients. You are talking markets, and markets alone -- what about economic fundamentals? They are weak to bad to terrible,l depending on your industry and where you live, and they are getting worse. Bulls continue to emphasize the "second derivative" -- the rate of decline is slowing -- is that a reason to think things are getting better? And your historical analyses did not include one simple fact -- markets always regress to the mean of corporate earnings, and they are going down and even though the market may not stay there, the market has to do this, based on HISTORICAL comparisons, so that means an S+P 600 or much worse.

Let's argue this over drinks at the Money Show in Las Vegas, if possible.

Michael Shulman

May 03 10:22 PM

[inthemoney:]

The higher you soar the more painful the fall. Lack of a healthy pull back is not a good thing. It just shows that the market is anything but healthy or stable.

May 03 10:42 PM