Tom Brown
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It should come as no surprise that investor sentiment regarding the financial stocks is turning up a lot more slowly than the stocks have themselves. That always happens at the start of bull markets.
But this is ridiculous. The S&P Financial Index has doubled over the past two months. And this time (unlike what happens at a lot of market bottoms) the rally has been accompanied by no shortage of signs that both the economy and the financial system really are getting better. Banks’ first quarter earnings were better than generally expected. Mortgage activity is exceptionally strong. Lending spreads are wide. More broadly, a number of classic leading indicators, from unemployment claims to consumer sentiment, look like they have begun to turn.
Reasonable people can disagree whether the bear market really is over. But given the fundamental improvements of the past couple of months, the objections the skeptics are lately coming up with are looking more and more, shall we say, unconvincing.
Take, for instance, what one of the Wall Street Journal’s resident bears, Greg Zuckerman, had to say Thursday morning. “The worst may be over for the financial system,” he warns ominously, “but some banks shares continue to look dangerous.”
Zuckerman then cites Umpqua Holdings, out in Portland, Oregon. He writes “[E]ven if [credit quality does] stabilize, the stock trades above tangible book value, generous for a bank expected to lose 10 cents a share over the next four quarters.”
Huh? Zuckerman seems to not be aware of Lesson 1 from stock market school: stock market discounts future events. In this case, investors might be assuming (not unreasonably) that the company’s credit problems won’t last forever. Once credit problems peak, furthermore, Umpqua’s earnings are expected to recover to some “normal” level, which we expect to be around $1.25 per share—which means the stock trades at just 8 times recovery earnings. For perspective, Umpqua traded between 12 and 20 times before the credit crackup. Similarly, why does Zuckerman think that the stock can’t or shouldn’t ever trade above its tangible book value? Again, before the credit crunch hit, the stock traded at 2.8 times book, on average, and occasionally traded as high as 4.4 times book.
This isn’t complicated. A number of investors apparently believe Umpqua’s credit costs will stabilize this year and decline over the coming two years, which will in turn set the stage for the company to resume its normalized earnings power. Of course, by the time that actually happens (going back to Lesson 1 for a moment) the stock will be much, much higher. That’s the point at which Zuckerman will presumably announce that it’s no longer “dangerous” to own the stock.
Another Perma-Bear: Paul Krugman
Then there’s Paul Krugman. On Monday, Bloomberg quoted him in Shanghai: “It looks to me now,” Krugman remarked, “as if the markets are now pricing in a rapid recovery, that they’re pricing in a V-shaped recession, which I consider unlikely. The market seems to be looking as if this is going to be an average recession, but it’s not.”
Hold on there, Mr. Nobel Prize Winner! You won the award as an economist not as an investor. There is no way investors are pricing in an average recession or rapid recovery. They can’t be: the recession is already over 16 months long, which makes it the longest in the post-war period. And the peak-to-trough decline in the overall market qualifies as the second-most-severe bear market in history! To say that investors expect this slowdown to be average is preposterous.
Krugman can speak with authority (if not always accuracy; he’s an economist, remember) on when and what shape he expects the economic recovery will take. But he and other economists (Nouriel Roubini, for instance) step outside their circles of competence when they start predicting where the stock market is headed.
The uber-bears have “enjoyed” one of the largest, deepest bear markets in history. But perhaps a few of them have become oversold on their talent for predicting the future. Cycles are still cycles. The bears would do well to step back and be more objective in sizing up whether this one might be turning.
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This article has 32 comments:
You are of course absolutely correct, but you missed one trick, the most convincing argument for a sustained growth of the stock market is that the bears are getting so emotional.
As I'm sure you know, the most dangerous time in the wilderness is just before the bears go and hibernate.
The recession is not likely to deepen further; however, there is a huge difference between 1.5 and 3 percent positive growth for 2010. 1.5 percent doesn't support retail, autos, or new home construction. 1.5 percent is so imperceptibly sluggish to the consumer that it looks like a recession. Consumer confidence is about perception. GDP or no, when Ms. American Christmas Shopper sees the unemployment number hit 10%, she will go hide under the bed and hibernate.
Where's the aggregate demand? Where are all these sacks of cash that John Q. Public is supposed to spending thought to be coming from? In 2006 in 2007, personal consumption outpaced disposable income. If these were the good times, how do you suppose the lean times will shape up?
It always makes me laugh when people argue like this online. Because it is nearly impossible to gauge people's emotions through written text, everyone ends up projecting and filling in whatever emotions they think their opponents are feeling. And most people think that their opponents are feeling more emotional than they are themselves, because cooler heads are supposed to be, well, cooler. I see this particularly common among men who love to pretend to be cool because of the cultural stereotype of how men are supposed to behave. The fact that written text cannot effectively communicate the level of emotion is conveniently used to project whatever emotion you want the other to feel, not realizing that the same can be done from the other side of the fence.
If the stock market discounted future events, it would have not made a new high on October 2007 because the future was getting worse and not better.
The bulls' blindness is getting old.
Lets get something straight. I find it funny that people like this seem to assume that bears are all the same - first comes their pre-disposition to having a bearish outlook, then comes their flawed reasons why the economy is sucking, and will continue to suck.
In fact, there are many (like myself), who dont have a bearish predisposition, yet the facts that present themselves bode strongly for, at best, a flatline in the economy, where the only gains to be had in the markets will be due to a massively inflated currency.
When you add this to the fact that the people running this game (country, financial system, markets) are CROOKS, then you see how many can think that this market is overly dangerous. The wall street boys are desperate, and they pull the levers of the markets -- that means your money is at much more risk than normal, as the desperate crooks will play their games to fill their credit holes, at the regular investors' expense.
There are alot of reasons to /not/ be in the market. Any BULL who denies that is very naieve indeed.
The old snowball theory everyone knows.
About as good as the next theory.
Why are you so in love with financials? Most major banks are truly insolvent despite government aid. I've told my clients ever since 1997 to NEVER own two sectors of the stock market - the two most overly-hyped sectors - financials and tech.
I expect a rush to commodities as well, but not because the economy is great and tons of people want to buy stuff. I expect it because it also is a inflation hedge against Robin Hood and the government mad money machine.
I suppose my calling the federal government, Treasury, and Fed's actions Robin Hood like is a bit misplaced. They steal from the public and give to the rich running bankrupt corporations in the public's interest. Maybe I am a bit brainwashed like the public into thinking they want to be like Robin Hood.
After all they tell us that they are saving the banks, insurance companies, and brokerages for the sake of the public. To support mega banks and fat bloated quasi government institutions like Freddie Mac that loose billions in a blink of an eye is tantamount to putting food in your mouth or mailing you a check. They do it to save you. To save us. The common people. Do you buy it?
Personally, I'll buy a real recovery the day Citibank goes to bankruptcy court. Sure it may hurt, but the way things are going now we will never truly recover. We must recover our free market system and sanity first.
Yeah, right. Tell that to the investors who bought the Nikkei at 41,000 almost 20 years ago.
My two cents are as follows -- from a value investing point of view... the current state of the market is like shooting fish in a barrel...
I read The Intelligent Investor years ago... saved up about 25K and threw it into the market in the literal week the current rally of interest started (nice crystal ball I must admit)... I'm up 67%(after taxes) on minerals/mining/oil and dividends.
This is literally my first forray into the market... after years of waiting for the right moment I chose March of 2009...
Brilliant I must admit :-)
I am constantly amused by the doomsday sentiment on this site... I agree there are credible probabilities assigned to the worst outcomes... however they are minute... it is much more likely that the powers that be (who have the greatest vested interest in maintaining this massive feudal system we call "the markets") will find a way to restore the system using its own internal balance. Near to mid term some type of reasonable valuation for equities should manifest... that's my so called reasonable approach.
For all of those expecting a doomsday situation and investing in gold or holding cash... in a doomsday scenario you're more likely to be robbed or severely ripped off than to find a liquid market to trade... if you're at all worried about that outcome you should probably invest in a remote cabin, a rifle and take some hunting lessons - a pilots license and a private airstrip or two would likely also come in handy.
Anyhow needless to say, with 67% gains on three months, I've got rose coloured glasses -- I can't wait to see how my simple optimism will be shattered against the wall of Wall Street in the very near term -- but for the rest... I'm long... way long... the current opportunities the market affords are once in a lifetime type occurences.
As I have always said everytime I have tried to judge the direction of the market based on my own anaysis I have been wrong. I just follow the trend. We have had a negative week and yet the charts don't say the trend has ended. If the trend does end I will jump ship and let my bearish emotions come out in full swing and have a good cry with all the bears. Meanwhile, I will finger those crispy currency notes I have in my pocket thanks to the recent bull market which I benefited from by just following the trend rather than sitting on the sidelines like most bears shaking their heads in disbelief. Why people just don't follow the market rather than sitting on the sidelines and trying to second-guess is beyond me!
Again, the mistake is being made in thinking that just because people are bearish on the economy and the market in the long term, that they dont trade the trend in the short term.
I was all-in above SPY 75, and also enjoyed great gains.
Arguing a short-term stock market rally along with overall bearishness is arguing apples and oranges. All I had to see is an extremely oversold RSI on the SPY monthly charts and I was convinced taht the markets would bounce LOUD.
Also -- whos crying ? People that see all the factors and judge them to be very negative for the economy are crying ? How bout perhaps they are trying to get across a TRUTH that seems readily apparent -- at least to those who can separate TRUTH from simply making money in a market.
I still havent heard HOW the economy /can/ improve beyond the wild hyperinflationary money printing. Its not that there are no signs that it cold recover -- its that Ive heard NO possible arguments as to HOW it could recover sustainably.
So stocks are fairly valued here, based on fairly optimistic measures of forward earnings. The market is gapping up and down by big measures on the open. The volume isnt anything to write home about. Given all of this, tell me you dont see markedly heightenned risk in putting money 'to work' from this point.
Sure Ill play the trends -- but Ill hold my nose at the same time.
I have my 35%. Rinse, and repeat.
1/ A productivity enhancement
2/ The aquisition of new resources
Our current debt load and the consequent ability of large foreign powers to influence the value of North American currencies makes it possible for only a hawk to fly.
is blatantly biased in favor of whatever the banks might want.
Banks have their place in our society but they should not become
oligarchs if we want to keep our society healthy. That said, a
cynical case could be made to invest in large bank stocks since
it is those companies favored by our generous government.
On May 17 09:00 AM archman82011 wrote:
> To have to wake up on a Sunday morning and read an article by Tom
> Brown, makes me wish I did not make it thru the night.
> My whole deal is telling people what they NEED to hear, rather than
> what Wall Street and the financial media WANTS them to hear.
This reply is exactly why I am a regular reader at seekingalpha. You get called on your words. I beleave the reason Newspapers are dying is they no longer have REPORTERS with code they have EDITORIALIST without code. Anyway nice piece of homework !
While it's impossible to argue against the idea that the masses opinion of the safety of equities is a strong negative indicator, I don't believe the seekingalpha community is representative of the average investor. Most people in this community actively follow the newscycle, and have healthy skepticism about whatever they hear on CNBC. Moreover, a significant amount of the posters here have some skill in doing their own research and due diligence.
There are plenty of reasons to be bearish. The most significant one is that bear markets don't end at 22x projected year-end earnings. That's where we stand right now. A double from here would be valuing companies in a time of suspect growth at Internet Bubble PE's of 44x 2009 earnings! If valuations are halved from here because of the continued drag on earnings and the consequent weakness in investor sentiment, the market would be valued at a conservative, yet still fair, 11x 2009 earnings.
I offer that as only one example of legitimate reasons to be prudently bearish. I also want to caution you to believe the seekingalpha community shares the same demographic as the CNBC Jim Cramerites who are much more reliable negative indicators.
Dave
On May 17 12:28 PM InvestBaboo wrote:
> This is very good. Almost all the comments here are bearish and many
> extremely bearish in nature. By definition such overabundance of
> bearish sentiment in the early stages of a bull market is good because
> it helps sustain the rally and take the market to new heights.<br/>
>
> As I have always said everytime I have tried to judge the direction
> of the market based on my own anaysis I have been wrong. I just follow
> the trend. We have had a negative week and yet the charts don't say
> the trend has ended. If the trend does end I will jump ship and let
> my bearish emotions come out in full swing and have a good cry with
> all the bears. Meanwhile, I will finger those crispy currency notes
> I have in my pocket thanks to the recent bull market which I benefited
> from by just following the trend rather than sitting on the sidelines
> like most bears shaking their heads in disbelief. Why people just
> don't follow the market rather than sitting on the sidelines and
> trying to second-guess is beyond me!
1. Alt A/Option ARM resets. While low interest rates are helping that is countervaled by rising unemployment. It is bad enough that the default rate of even prime mortgages is rising. Nobody talks about primes, but if such a mortgage goes underwater why wouldn't the same rules apply?
2. Commercial real estate resets.
3. The world economy - Europe isn't doing very well either.
4. Government spending is at unsustainable levels. Debt is rising too quickly.
5. This recession has not only crushed 401Ks but is exacerbating the problems of Social Security and Medicare.
6. Ripple effects from the auto industry.
While I wonder about S&P earnings reflecting a lot of write downs, and earnings from operations being better ex these write downs, it also seems to me these write downs will be with us for a while yet because real estate is still in a world of pain.
I am hoping things don't get significantly worse, and that there will actually be a V shaped recovery. But I'm being realistic that there are some damn big barriers in the way of this scenario that need to be resolved before this will happen.
This is the biggest banking and financial crisis of the past 70 years, and it could still evolve into the greatest financial crisis of modern history due to its global nature and the synchronized global deleveraging that is going on and which hjas still a long road to run.
Mind you, I am long a boatload of high quality stocks (i regard them as such, at least) and even a bank (WFC) but I won't assume them to return to pre-crisis earnings any time soon. It will likely take years and those people who are buying these stocks NOW are either chasing momentum or are betting indeed on a quick, sustained strong recovery.
All anyone has to do is plug in 5-10 data points from THEIR OWN LIFE to realize that nothing is getting better.
Multiple friends/family out of work
Employer's business flat/down
Both of the above paying down debt.
Conservative spending from the above
Other note if it wasn't for the gov't (retired gov't worker, umemployment, and my employer's customers sell to gov'ts) my own perspective would be depression, not recesssion.
How that translate to the econmy coming back, I just don't see it.
On May 17 05:55 AM Andrew Butter wrote:
> Takes a brave man to say nasty things about bears these days.
>
> You are of course absolutely correct, but you missed one trick,
> the most convincing argument for a sustained growth of the stock
> market is that the bears are getting so emotional.
>
> As I'm sure you know, the most dangerous time in the wilderness is
> just before the bears go and hibernate.
The rest, i'll wait for it to START to catch up in a couple years. Remember, Uncle Sam only has a linited amount of dollars to spend before eveyone bails and leaves them owning the Banks :)