The Bear Market Isn't Here Yet - Bezek's Daily Briefing

by: Ian Bezek


The rally continues, with stocks moving much higher again Wednesday.

Markets don't sell off due to valuation.

Analyst ratings are still conflicted, beware.

Just three trading days later, the Dow finds itself a cool 950 points off Thursday low. The S&P 500 (NYSEARCA:SPY) is +116 off its respective low. The Dow has rallied 200 or more points each of the past three days, making this the biggest 3-day rally since August.

The proximate cause for Wednesday's continuation of the rally appears to be that oil (NYSEARCA:USO) resumed its upward climb, for reasons not entirely apparent.

Also, the Fed minutes showed that many members of the Fed are finally becoming aware of international weakness and the continuing lack of the long-awaited inflationary pressure.

But no, none of that is the real cause of why we were up so much on Wednesday.

Let's Talk About Sentiment

If you read the Briefing regularly, you'll know I said on various occasions that things had gotten way too bearish way too quickly. People were quick to criticize the bottom call, because it was based on nothing tangible.

When asked why we would rally, I really couldn't come up with much more than "because everyone is bearish." I had (and still have) little rational justification for markets going higher here. The world economy has major issues, the US has an earnings problem, and everyone faces headwinds from a confused Fed making markets nervous with double talk.

Most intelligent people are probably bearish here. I, for what it's worth, would bet markets will close 2016 lower than they currently trade if forced to pick a side. The current (and upcoming) rally will likely be short-lived.

But for now, we're going higher. 2,150 on the S&P is very much in play this Spring. I'll keep saying it until I'm blue in the face, we probably see one more new high on the S&P 500 before the next bear market hits. Why?

Simply that people got totally shaken up in January for no particular reason. That much panic with so little (new) reason indicates an overly fearful group of investors. Markets tend to cause the most pain to the most participants possible. If everyone is leaning toward a bear market, we'll go up first to make those people pay up and sucking in new bulls before pulling out the rug.

For memory's sake, let's ask ourselves: Why did the market drop in January?

China? Most people have known China has had major problems since at least August - little new info there.

Earnings? Earnings have been a muddle since the dollar (NYSEARCA:UUP) started its meteoric rise more than a year ago. Anyone getting very bearish in January 2016 because of earnings is either late (earnings became an issue previously) or early (since earnings haven't gotten materially worse since year-end 2015).

Oil? The S&P 500 held up alright when oil fell from $100/barrel to $35/barrel, but apparently that last $10/barrel drop was suddenly enough to usher in a bear market? Consider me skeptical.

As I noted, people became convinced this was a bear market even though the market didn't even get close to the 20% down barrier where bear markets start. I showed Google data that demonstrated that there was far more interest in the term "bear market" than there had been in 2011-12, when the S&P dropped farther, and the European political and banking system teetered on the brink. The market fell to similar depths in August, also without causing everyone to get so profoundly pessimistic.

You can tell me the impending failures of energy companies like Chesapeake (NYSE:CHK) is a problem; I'd agree. But to suggest 2016 started in more perilous shape than 2011 seems too much. Major European bankruptcies on the horizon seem more important than isolated wipe-outs in the domestic energy sector.

Consider this:

In just two months, we've taken rising interest rates and "releveraging event risk" off the table. In return, we've gotten more oil and China concerns, without much additional substance to fan those flames.

Switching gears, a reminder is in order. Markets don't sell off because of valuation. People don't tend to wake up one day and say: Man, the market is expensive, better sell.

In the long run, the so-called weighing machine that is the market will mark down overvalued stocks. But people sell stocks off in the short run with votes of fear regarding actionable catalysts. Valuation is never a catalyst; you need valuation plus something else to cause a severely overpriced stock (or underpriced one for that matter) to head back to fair value.

The January-February 2016 correction was a violent reaction to already known appreciable risk factors. The moves in bonds and gold in particular were stunning given the lack of any underlying change to the economy versus, say, November 2015.

A bear market is coming; probably sooner than later. But it will be driven by something the market hasn't priced in yet. Petrobras (NYSE:PBR) going bust (Brazil got downgraded further into junk territory Wednesday in a headline well-hidden by the equity rally) for example. Or perhaps a European bank failing. Or perhaps the Canadian housing bubble will have unexpectedly broad consequences as it pops. Who knows?

What it won't be is oil going to $20 or China slowing further. These risks are already well known and the associated stocks have already gotten bombed out by the market. That's all old news.

There were a bunch of articles here at Seeking Alpha and elsewhere this past week suggesting we're starting another 2008 or, according to at least one, something worse! This is classic recency bias. The human mind is designed to find patterns, even in random data. For people who have only traded through one bear market in their life, they'll assume the next one will look much like it.

But 2008 style collapses are extremely rare (once in a lifetime) sorts of events, and it's a particular hazard younger investors face in assuming every bear market will be similarly disastrous.

For a better parallel, consider 1997-98. That was another emerging markets lead bust, led by weakness in Asia, a surprise bankruptcy in Russia, and general morass across other big EMs such as Brazil. Sound familiar?

Adding to the comparison, it came at the end of a very long bull market that had spanned the whole of the 1990s, just as the current bull has been running 7 years now. Stocks gyrated wildly, falling as much as 15% off the highs, but never broke into a bear market. Stocks stabilized and made one last big push higher in 1999 before the long-overdue bear finally hit hard in 2000.

Valuations were similarly questionable (arguably worse) in 1998 than today, with both internet companies and old economy stalwarts such as Coca-Cola (NYSE:KO) and Wal-Mart (NYSE:WMT) trading at otherworldly multiples. And yet, despite various significant global dominoes toppling, the market held tight and eventually went higher.

If you're in all cash or net short the market, carefully consider whether this might be another 1998 type of situation. I'm not saying this is necessarily 1998 either, but make sure you have more models through which to see the world than just 2008. Not every falling stock market is 2008 all over again.

Falling Unicorns

Speaking of valuations, I thought this chart was fascinating:

Click to enlarge

I don't really have a lot to say about it, mostly just wanted to pass it on. I would note simply that if you're trying to find the next Facebook (NASDAQ:FB), be very careful. Other than LinkedIn (NYSE:LNKD), which was successful for a few years before its recent blowup, the entire batch of high-profile IPOs have been big time losses, usually within 18 months.

The vast majority of high-profile touted IPOs end up being massive dogs. Insiders get rich precisely because they get to cash out near the top selling to you. They go public once they figure valuations are getting near their terminal peaks.

Conflicted Analyst Ratings

Finally, on a somewhat related note, remember that analysts lie. If you thought corrupt brokerage ratings was a problem solved in 2000, think again.

The SEC put out a press release that starts as follows on Wednesday:

Washington D.C., Feb. 17, 2016 -

The Securities and Exchange Commission today charged a former Deutsche Bank research analyst with certifying a rating on a stock that was inconsistent with his personal view.

An SEC investigation found that Charles P. Grom certified that his March 29, 2012 research report about discount retailer Big Lots accurately reflected his own beliefs about the company and its securities. But in private communications with Deutsche Bank research and sales personnel, Grom indicated that he didn't downgrade Big Lots from a "BUY" recommendation in his report because he wanted to maintain his relationship with Big Lots management.

Grom agreed to settle the charges by paying a $100,000 penalty, and he will be suspended from the securities industry for a year.

Got that? Mr. Grom of Deutsche Bank (NYSE:DB) said to buy Big Lots (NYSE:BIG) in public, but privately thought otherwise. He chose not to downgrade the firm because it would harm his relationship with Big Lots' management.

I can assure you that for every case like this that gets caught, dozens go unnoticed. Brokerage research is interesting and can help confirm or contrast with your investment thesis, but never use it as the Bible on anything.

Particularly for smaller cap companies or ones that frequently do bond and equity offerings, the flow of banking fees is tremendous. Analysts that say too many negative things may see their performance reviews come back poorly and face more scrutiny and reduced bonuses. The bias is to be too optimistic and not make waves.

Disclosure: I am/we are long KO, WMT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.