Is the Bullishness Really Justified?

May.21.09 | About: SPDR S&P (SPY)

Yesterday on Bloomberg, Mr. Laszlo Birinyi stated that we are in a bull market and the S&P 500 may surge 88% to 1700 over the next two or three years.

Now I have read many articles over the years by Mr. Birinyi and he is an experienced and smart investor. I happen to think he is wrong in this case. If by chance he is right, the stock market will then see another even more devastating crash. Why?

I am a big believer in the theory of reversion to the mean. I believe that a healthy resetting is always required for the stock market to continue a move upwards over long periods of time. The recent bear market certainly fell into that category. The S&P 500 finally reverted to its 25 year continuation trend line.

Please see the following chart:

Click to enlarge

Folks, there is danger ahead. The market, after 14 years, two bubbles and two crashes, has finally reset itself. All the excess was washed away. Now, though, instead of a market that has the potential to just follow the gentle upward slope of the continuation trend line, we have a market driven by to many hedge funds, to many institutions, coupled with to many bullish calls for S&P 1100 by years end.

I have indicated on the chart what more than likely will happen if Mr. Birinyi's prediction of 1700 on the S&P comes true. The farther the S&P travels above its long term trend line, the farther and harder it is going to fall back to that point. While the rise up can make those who buy low and sell high, a lot of money, for most people, there will be no wealth creation.

Why? Statistics show, after the sort of bear market we just experienced, it typically takes a very long time before the average person has trust in the stock market again.

Worse, the average person almost always starts buying stocks again "after" stocks have gone up significantly from the lows. Is the average American back in the stock market yet? Of course not. When will they get back in? Probably once the S&P gets above 1100 again. When will many more get back in? If Mr. Birinyi is correct in his S&P 1700 two year target, many people will get in above 1400 on the S&P thinking they have missed it all, but its not to late to get on board. Then, per my chart, disaster will strike, reversion to the mean will take place, and once again as per history, many people will lose it all.

I am never really sure where the market is going to go. There are two things I have learned over the years, however. The first is never be to bullish and never be to bearish. Either extreme will send you into a world of hurt at some point. The other is always look at the very long term big picture to access stock purchase or general market index direction. From where I sit here, the market is more than fairly valued here based on all news and earnings we have seen over the past few months.

Disclosure: No position in SPX