Making the Bullish Case - But for How Long?

by: Thomas J. Feeney

I received a call last week from a friend in his 80s who has spent many decades as a highly successful business owner and investor. He had belatedly read my year-end commentary. He was highly complimentary of that report’s insight into the critical variables that will likely determine economic and market success or failure in the years immediately ahead. While he sees potential long-term problems in the area of excessive debt and unstable political systems in leading emerging countries, he is very optimistic in the near term.

He sees positive momentum building, with tremendous liquidity in the economy and in domestic corporations. He anticipates decreasing unemployment, increasing sales and a far-better-than-anticipated 4-5% GDP growth rate. Costs are very low; margins are outstanding; corporate earnings are very good. He views the current situation as similar to that in both 1936 and 1984. In both of those years, the economy was rebuilding momentum after serious economic hardships. Strong economic growth in both instances led to powerful stock market advances. My friend sees a strong stock market as highly probable this year as well, with all stars properly aligned in the period leading to the 2012 election.

We agree that the strongly bullish forecast is on one end of the spectrum of possible outcomes. Its realization, however, requires that many significant fundamental problems remain on the back burner and not move to the forefront of investors’ consciousnesses.

Drawing parallels to 1936 and 1984 certainly lends hope to investors, because stocks climbed strongly in 1936. Stocks rose only moderately in 1984, but then jumped strongly again in 1985 and 1986. It is important to recognize, however, that stocks plummeted in 1937 by 35%, and prices in 1942 were still below those that immediately preceded the 1936 rise. The rise from 1984 to early 1987 was impressive. While 1987’s 37% crash was painful, it did not erase all of the gains from 1984.

One giant difference exists between today’s financial environment and that of a quarter-century ago: In 1984, the United States was the greatest-ever creditor nation in the history of the world. Today, we are the greatest-ever debtor nation in history. We are no longer the undisputed captain of our financial ship. Unless we are willing to walk away from our debts, we are now dependent upon the willingness of others to continue to fund our monumental deficits.

Excessive debt is the single most important component in the worldwide financial mess. Governments and central banks around the world are exerting tremendous efforts to solve problem after problem arising from the excessive debt that is leading countries, states, cities and banks to the brink of default. Continuing to keep most of the balloons in the air depends upon keeping investor confidence sufficiently high. As international activities of the past several weeks demonstrate, geopolitical incidents can suddenly change the landscape.

Admittedly, my friend is strongly bullish only for the next 12 to 13 months. Beyond that, he fears that negative fundamentals may move to the forefront of investor consciousness. My concern for investors (not speculators) is that the depth of fundamental negatives, especially excessive debt, will exert its influence sooner than bullish analysts anticipate. Which brings us back to the overriding question: Will government win its bet and succeed in bailing out an overindebted economy with more debt, or will underlying negative fundamentals overwhelm the best efforts of central planners?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.