Have We Just Begun A Secular Bear Market?

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Includes: DIA, QQQ, SPY
by: Brian Gilmartin, CFA

In a word, I would say, "No". But it's being played up in the financial media like the recent PowerBall Lottery grand prize.

Could the SP 500 and Nasdaq correct 20% - 25%? Absolutely.

While perusing Twitter last night during the football and Blackhawks game, this tweet of Todd Harrison's was in the queue, courtesy of Todd linking to a post by @zerohedge.

Todd Harrison is a wonderful guy, a former partner of Jim Cramer at Cramer & Berkowitz, founder of Minyanville media company and a great trader in his own right, but like a lot of hedge fund stars, typically tilts to the bearish side of the ledger.

The one critical element to this correction so far is that unlike 2000 and 2007, there isn't a sector that has risen to a disproportionate concentration of the SP 500, as Technology did in 2000 at 33% of the SP 500 by market cap, and Financials in 2007 at 25% - 30% of the SP 500. In fact I would argue Financials were a much bigger part of the SP 500 in 2007, since - in 2007 - GE Capital wasn't included as a Financial (near the peak in 2007, GE Capital's assets were roughly 80% of consolidated GE's balance sheet, except for the fact that GE was listed as the largest Industrial component in the SP 500). And if we would have included Boeing Capital, Caterpillar Finance, Deere Capital, Honeywell, etc. and all the captive finance subs of the Industrial sector, I often wonder if Financials weren't closer to 40% - 50% of the SP 500 in 2007.

bear market It was actually from Todd Harrison that I learned that a sector's market cap percentage of the SP 500 can be a good tell, if there is a brutal bear market looming.

Today, Technology is just 20% of the SP 500 and Financials are 16%. The Energy bear market would have been far worse, except for the fact that when crude oil started to fall from $100 per barrel down to $30, Energy as a percentage of the SP 500 was just 12% in mid-2014, and is roughly 7% today.

The problem I see is the fact that the US economy cannot generate any sustainable growth. The reason central bank liquidity has seemed to have generated nothing more than a dis-inflationary, deflationary, liquidity trap, points back to the financial system in my opinion. The US economy today seems to be like a 35-year old man trying to run an Ironman with the heart of a 12-year old child. The body can't get enough blood and oxygen to be able to move faster. With Dodd-Frank, the Volcker rule, the regulatory scrutiny, and the risk-averse nature of banking today, more like functional utilities in fact, the banking system regulations are perhaps stifling longer-term growth.

Back in 2012, or 2013, Rick Reider of BlackRock spoke to the CFA Society of Chicago and said that the next burst of economic growth would come from "Financial Re-Leveraging" and he showed a graph of the leverage within the financial system that at that time was still lower than the mid-2000s.

I don't know that that has happened yet.

When Tim Geithner wrote Stress Test, he made a point in the book about recessions and financial crises that is very applicable to investing. He said when 2007 started, at the time, the Fed's and FOMC's response was just like any other recession. It wasn't until 2008 and well beyond the start of the recession that the Fed and Treasury suspected that something far more treacherous was afoot.

Since the SP 500 hasn't made a new high since last July '15 and we've seen a brutal start to the year in terms of SP 500 returns YTD, does that mean a repeat of 2000 and 2007 is at hand?

Again, I think not. What I worry about is stock market decay by boredom, and lack of meaningful growth. This isn't a political statement, but growth and prosperity are somehow deemed bad today, and "not fair".

The SP 500's valuation is still reasonable, and stock market sentiment is pretty poor. However I also can't say that those leaning bearish won't be right.

If the SP 500 can't trade back above the December '15 lows of 1,993 and 2,005, then we could eventually see 1,750 on the SP 500 for a near 20% correction.

I do think that this stock market and really, credit markets too, are a long way from a 2008-type scenario.