Our own bearish beliefs remain unchanged. From day one, we’ve said the current rally is one for suckers. But we admit suffering certain twinges of regret; stocks have proved more resilient than we expected. Here’s a quick bullet list of why we remain bearish on stocks’ near-term prospects:
1) We don’t like the smell of fish. This rally began with a ‘leaked’ memo from Citigroup announcing a return to profitability and was given legs by banks’ bogus quarterly earnings. Washington has added to the stench with its fudge tests for banks, its PPIP proposal and its active campaigning to relax mark-to-market accounting rules.
2) Much of the buying was caused by short sellers covering their positions (a massive “short squeeze”).
3) “Junk” stocks have been leading the rally. The real winners have been beaten-down stocks with the riskiest outlooks. They generally have had the highest level of debt and the lowest return on equity.
4) Historically, sucker’s rallies are the norm, not the exception. Sharp crashes are often followed by sharp, but short lived, bear market rallies. The 2000–2002 bear market had three, with the Dow gaining an average of 21%. The 1929 to 1932 bear had six, with an average gain of 47 per cent. Even the poor Japanese have suffered their head fakes. The Nikkei has seen about 14 false downs since it crashed in 1991.
5) Generally, bottoms don’t feel like this. Bear markets typically end with a whimper rather than a bang. A recent study by Hussman Econometrics analysed numerous US market bottoms and bear market rallies. It revealed that, with the exception of the 1987 crash, the month before the lowest point of a downturn saw a gradual descent.
6) Stocks are still too expensive. As Yale University professor Robert Shiller says, all four big bubbles of the 20th century troughed at between 5 and 8 times earnings. Stocks did not even fall below 11 times earnings in the recent low.
7) Insiders have been selling the rally. According to TrimTabs, April saw the lowest level of insider buying ever recorded, with insider selling 14 times as high. And companies sold 64% more shares than they bought.
Sentiment isn’t low enough yet for our taste. As Russell Napier says in Anatomy of a Bear , “For the great bear market bottoms, you need a society-wide revulsion with equities. It just doesn’t smell like the big one yet.”
9) The risk of corporate bond defaults is at highs unseen since the Great Depression. Moody’s expects the corporate default rate in the US to reach 14.6% by year end – a near doubling from the first quarter’s default rate of 7.4%.
10) Corporate earnings continue to suffer. Earnings weren’t as bad as expected last quarter. But they are expected to continue to decline until sometime next year.
11) The S&P 500 remains under its 20-month moving average. Every sustainable bull market has been marked by the S&P rising above its 20 month average.
Suffice it to say, we’re sticking to our guns. As Merrill Lynch economist David Rosenberg recently counseled, “For those that missed the big nine-week move, don’t worry. Be patient. The story was right – the tortoise always wins the race.”