Defending This Bull Market Once Again

Eddy Elfenbein submits: I defended the bull market four months ago, and I’ll try to do it again today. This time, however, I want to take a look at some of the bearish arguments making the rounds. David Gaffen at Marketbeat outlines a few.

For example:

The VIX, commonly known as the "fear index," is hovering around 10, a low point, suggesting a lot of carefree folks out there these days. This level is often a turning point, a calm before the storm, so to speak.

No! No! A thousand times No! A low VIX does not mean that investors are complacent. It means the exact opposite—investors are being cautious. Notice how all the other risk spreads are also low.

The current rally is now the third longest since 1900 without a 10% correction.

That’s true, but what's so special about 10%? The S&P 500 had a 7.7% correction last spring, and it kept going. This bull hasn’t exactly been a roaring bull. In almost ten months, we’re up almost 10%. That’s less than both earnings growth and dividend growth. Look at some sentiment indicators. Value stocks are still leading growth. The Nasdaq is still less than one-fifth of the Dow. These aren’t the signs of an overheating market.

Margin debt has hit an all-time high, surpassing the heady days of the technology stock boom, as more people borrow money to buy stocks than ever before.

But what about equity growth? The proper way to look at margin debt is its relation to equity. Why isn't margin growth a good thing, reflecting investor optimism? (Update: Bill Rempel makes several good points on this misleading stat.)

The Dow industrials, transports and utilities all closed at new highs on the same day last week — something that became a routine occurrence in just two years, 1929 and 1986, both preludes to big market falloffs.

The last two triple highs came in March 1998, and the Nasdaq promptly tripled. The time before that came in April 1993, and the market rallied for another nine months. Nearly anything can prelude a big market falloff.

Another bearish talking point is that the market hasn’t had a 2% down day in nearly four years. Once again, I don’t see what’s so bad about that. The market is in a period of low volatility. There’s nothing unusual or dangerous about it. Today’s volatility is roughly equal to other periods of low volatility. Was their anything dangerous about the market of the mid-1990s? There were just three 2% down days from November 1991 to July 1996, and we survived. Some of us even made money. Remember this was the market that led to Irrational Exuberance.

Also, what’s so special about 2%? Since the last 2% day, we’ve had over 60 1% falls, including a few 1.8%-ers and one 1.9%-er. Change the parameters slightly, and the talking point goes away. We’ve gone almost nine months since a 1% correction, and that’s far from the longest streak ever.

Comments

[Malkiel:]

Wisdom is knowing all the traditional indicators of market turns yet being willing to admit that current market conditions represent a new world that probably invalidates all of them, or at least requires them to be proven again in practice. This week every central bank in the world raised interest rates, yet every stock market in the world went up--so the usual suspects aren't sticking to the script...

2007 Feb 23 10:28 AM

[Panskeptic:]

This time it's different?

2007 Feb 23 11:38 AM

[Eddy Elfenbein:]

That’s right—market conditions are always different. The hard part, however, is spotting those differences.

2007 Feb 23 01:20 PM

[kevintx:]

Wow, excellent article, thanks.

2007 Feb 23 04:08 PM

[7c-ranch:]

I have been cautious since November, not bearish but conservative in my allocations. My performance should have suffered greatly in the traditional context of a bull market. Instead, the value, reit, dividend plays have vastly outperformed the market indexes and growth stocks, especially. Anecdotally, people just want to beat CD's, they are not bullish, they don't speak of great stocks. As to margin debt, I do know people borrowing against their holdings but it is a rational move vis equity return expections equal to or slightly higher than borowing costs. Over the past 15 years we have become rational borrows. It is also emblematic of people who have large nonqualified investments and say college tuition payments. My fear is these people dont think gold, commodities, utilities, reits, banks have the same risk as "stocks". When I speak of great value in growth stocks people actually turn white with fear. Try asking someone older than 50 what they think of INTC; if they have an answer the fear in their voice is almost palpable. So I am increasingly less fearful of US market valuations; now if someone could explain to me the relentless increase in foreign stocks vis US stocks, I would be most grateful.

2007 Feb 24 01:14 PM