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As the Battle Rages On

It's still looking like a toss up. Are we in a bull market, or a bear market bounce? Bulls and bears alike weild strong arguments for their case.  Bulls would argue that in terms of valuation, stocks are cheap.  The earnings yeild on the S&P 500 is over twice the yeild on a ten year treasury - under the Fed model, that makes the S&P 500 about 50% too cheap. Bears would counter that current earnings are inflated and likely to drop (lowering the earnings yeild) and the the US treasury market is in a bubble, likely to pop (raising interest rates).  If so, the Fed model is just sending the wrong signals at this point. Plus, bears will argue that if earnings revert to their 10 year mean (which is statistically very likely), stocks are not exactly expensive, but are by no means bargain basement priced.  Bull markets often are launched when stocks are cheap, not when stocks are reasonably priced.

Technically speaking, bears will note that the S&P 500 sold off at it's 200 day exponential moving average, and has since sliced through support at its' short term moving averages. Plain vanilla bear market bounce kind of stuff. 

Bulls, on the other hand, will point out that the short term trading momentum (as measured by the 50 day simple moving average) for ETFs measuring broader equities indexes (such as the Vanguard Total World Stock ETF - ticker symbol VT) have burst decisively through long term investment momentum measured by the 200 day simple moving average. On the recent pullback, VT has also observed its 50 day simple moving average as support.  Plain vanilla bull market stuff. Coincidentally, even though the 50 day exponential moving average for VT never crossed the 200 day exponential moving average, VT has, at least, observed its 50 day exponential moving average as trading support, establishing the short term upward trend as intact.

Bears will then point out there is that historic wave of deleveraging which continues to this day.  People pay more for assets when they use borrowed money, and so when there is less borrowing, one could expect asset prices to drop. On the other hand, waves of deleveraging can reverse on a dime, particularly when interest rates are low.  And bulls will argue interest rates are prone to stay low, given the slack in the economy and the utter lack of inflation-fueling demand on the part of consumers and businesses alike.

Conclusions:

The valuation debate is, frankly, unknowable. The reason why is that when it comes to interest rates and earnings, the future is unknowable.  The best we can do is look at where we have been, where we are, and then close our eyes and start throwing darts at what may be - hardly a scientific investment approach. Moreover, it is unclear whether value has anything to do with stock prices over a span of two to three years, anyway.  

So too with the economic debate. Companies might earn more when the economy is strong, but equities prices tend to be six or nine months ahead of the economy. By the time the economy turns upwards, stocks could be 30% or 50% higher, and perhaps starting to decline as investors anticipate the next recession.  And besides, the extent to which investor demand for stock increases in a robust economy is unclear. When the economy turns, will investors be willign to shell out a 10% premium for stock? 5%? 20%? Who knows. Equities indexes can swing 10% in a week, so ultimately, for a long term investor, who cares about the premium, if any, investors are willing to pay for stock in a robust economy.

The technical debate is clearer to make, but it describes where the bull/ bear debate actually is at any given moment. It will not tell us anything about the future, but can inform investors about what sort of strategy makes sense at the moment. If bulls are winnning the technical debate, we are in a bull market.  You cannot know how long it will last or how high it will go, but if you know you are in a bull market at the moment, then your strategy should be bullish, meaning, you should purchase upside risk.  If, on the other hand, bears are winning the technical debate at any given moment, you should shun upside risk and purchase downside risk.  And if the debate amounts to a coin toss, you should be indifferent to risk, which in my book translates to holding cash.