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There’s a saying among prospectors: “Go out looking for one thing, and that’s all you’ll ever find.” ~ Robert Flaherty

I’ve written a lot about how financial bubbles, socioeconomic bubbles, and over-leverage in the economy may have an adverse effect on markets in the future. My last article asked Have You Lost Faith in the Market?. I do tend to be pretty bearish, and I’ll probably stay that way until some of these excesses work themselves out and our financial system achieves some proximity to equilibrium.

But this blog is about balance, so I try to actively search out articles and viewpoints that do not match my own. It’s so easy to get drawn into the type of data mining to which the opening quote refers, so today I’m going to try to sum up some of the bearish arguments out there, but I’m going to make an extra effort to point out some arguments for the bullish case too.

Why the Market Could (Should?) Be Lower

The bearish case has received more attention than usual lately. Maybe we’re finally letting those grizzlies wear the white hats. In any case, here’s a brief summary of some of the reasons why the market could or should be lower:

  • Excessive Debt: I’ve written quite a bit about the tremendous problems we face in terms of servicing massive debt loads at all levels of the economy, so I won’t go into a lot of detail here. I would just like to point you to an article posted at Zero Hedge that described Nassim Taleb’s argument that government debt is becoming a pure Ponzi scheme.
  • Deteriorating Economic Fundamentals: About 80% of the economic data have either turned lower or disappointed compared to expectations over the past couple of months. Recent underachievers include U.S. GDP, factory orders, durable goods, and pending home sales.
  • Questionable Earnings Beats: One of the positives we’ll include below is the mainly good news out of the corporate sector during the second quarter earnings season. Skeptics point out, however, that many companies beat on the bottom line while revenues continue to disappoint. The results of the financials in particular have been called into question by Meredith Whitney and others on the grounds that earnings were padded by decreasing loan loss provisions. It’s possible that these banks may have to increase them again in the near future as they still hold loans on their books that should be marked much lower.
  • Political and Regulatory Uncertainty: Many corporations are reluctant to put capital to work expanding their businesses and hiring workers because they’re unsure what the regulatory environment will look like over the next few months, and maybe even years. Yes, the health care and financial reform bills passed in the U.S., but those bills only provide a rough framework with no real details on what the operating environment will look like down the road. Further, the continual debate over whether the Bush tax cuts will be allowed to expire or not only adds to the uncertainty. It’s pretty hard to make any decisive moves in a game where the rules are still on the drawing board.
  • Jobs, Jobs, Jobs: Even the most ardent optimist will usually admit that no one will feel really good about the economy until we see some decent job growth in the U.S.. This post will go live before the Friday jobs report, so we’ll see what kind of information that brings.

Why the Market Isn’t Lower

After reading the bearish case above, you may think that there are no reasons for the market to be exhibiting the relative strength that it has lately. But there are a few good things happening out there and we’ll focus on those in this section. Even David Rosenberg came up with 17 Reasons to Be Bullish about the Markets!

One commentator that’s usually pretty far over on the bullish end of the spectrum is technical analyst Leon Tuey. He believes that a secular bull market began in October of 2008, and often likes to taunt the bears with questions like Why Isn’t the Market Collapsing? Mr. Tuey (not surprisingly) played the bull in our last bulls vs. bears article back in April.

More recently, Wall St. Cheat Sheet has been doing battle on behalf of the bulls, offering 5 Reasons the Long-Term Bull Will Resume and 4 Huge Catalysts That Could Awaken Animal Spirits on Wall Street. I’ll sum up these bullish factors for your consideration here:

  • Europe’s Handling of the Recent Sovereign Debt Scare: The argument here is that the stress tests “were just harsh enough as not to be seen as a farce.” I happen to be one of those who did believe they were a farce, but the market’s positive reaction indicates that most participants disagreed with me and others on that.
  • Positive Second Quarter Earnings Reports and Improved Sentiment: Whether the reports were positive relative to easy comparables or not, earnings were indeed pretty positive overall, and that has contributed to a boost in confidence for some market players.
  • Downside Leaders GS & BP Have Stabilized: Goldman Sachs and BP seem to have recovered from the negative news spirals in which they were both caught for a while.
  • S&P 500 Traced a Higher Low: The charts show that the S&P 500 may be exhibiting the early characteristics of a change in trend.
  • Dr. Copper’s Economic Prognosis is Positive: The price of copper is widely viewed as a good mirror of economic activity and its chart has turned positive as well.
  • GM Rising from the Ashes: Recently announced auto sales were pretty positive overall, and GM is looking to raise money through an IPO. (I have issues with a taxpayer-funded bankrupt company accessing the capital markets, but there’s no disputing that auto sales have improved.)
  • Cheap Debt . . . Again: It’s definitely cheap to borrow money again. Whether or not that’s a good thing is very debatable.
  • Justice Served to Crony Capitalists: Although we haven’t seen a lot of perp walks in the wake of the financial crisis, the idea here is that they’re coming, and when they do, that will boost confidence in market integrity.
  • Job Creation May Surprise Sooner than Bears Think: We may find out whether this is correct or not when the U.S. Nonfarm Payrolls number is released this morning.
  • QE2: Many believe that no matter how difficult economic conditions become, global central banks can and will come to the rescue with as much Quantitative Easing as it takes to turn things around.

OK. So there you have some bullish bullets. There’s just one more outlook on the markets that I’d like to share with you. It’s ultimately bearish, but calls for a near-term rally. This one comes from Charles Hugh Smith, who offers this sunny prediction: Things Fall Apart, But Not Just Yet. This article explains the effects of feedback loops and cycles on the macroeconomic landscape and reminds us that states of disequilibrium can last for quite some time before “the sand pile suddenly cascades”.

Mr. Smith also offers some interesting thoughts on whether the stock market will crash before mid-term elections in the States. He points out that historical data show that markets are typically weak in the year leading up to the mid-term elections. But he thinks that we may actually see a decent rally as the administration needs the market to hold together until the elections are over.

If you think he’s talking about a few well-placed phone calls that somehow result in a nice boost that conveniently carries the S&P futures through some key resistance levels and triggers program buying by the machines, you’re right. I know a lot of people don’t want to think that this might be allowed, but I’m not certain that it’s entirely inconceivable. “After all, propping up the market as a proxy for the U.S. economy has been the strategy all along, and the worst time for the strategy to collapse in a heap is right before the mid-term elections.”

Whether you’re a bull or a bear, I hope the articles I’ve shared with you here help you think through your own views. As always, I’d love to hear them.

Source: Why the Market Could Be Lower...But Isn't