A very well-balanced reading on the current market...
"The seemingly unending Bear Market has got everyone calculating its length and depth. If March 10th, 2000 marked the beginning, then the current Bear is already 570 days old. During this time, the Nasdaq lost 72% of its value. In terms of the percentage decline, this is the biggest decline for the Nasdaq ever. The only comparison left is the 1929-1932 period, when the Dow declined by 90% for over 1000 days. Comparing today to the Great Depression may be inappropriate, but the truth is that the bubbles of 1929 and 2000 have many similarities and that has many Bears cheering.
So far, the Bears turned out to be right. The valuations have to get into the normal levels either by earnings growth or equity price declines or both. And now the Bears have another one going for them: FEAR. With things unfolding like they are investors may lose all faith in the stock market for the long term and fear will rule producing a Secular Bear Market instead of a Capitulation.
But why would most investors decide to escape this potential secular torture? It turns out that the Bull Market of the '90s was not very rewarding. Based on the net new money flowing into mutual funds in the last decade, the average purchasing price would correspond to 916 on the S&P 500. Fund inflows were much greater in 1999 than in 1990, so many investors got in at expensive prices. Now that the S&P 500 stands at 990, these "buy and hold" investors have gained just 8% in 12 years. If adjustments for inflation are made, investors who got into the stock market during the 90's have have on average lost money. That is enough to make many "buy and hold" believers depressed and force them to avoid the stock market until the new Bull is back.
To suggest an answer to the question whether this Bear is CYCLICAL or SECULAR, we must look at a few determining factors.
When viewing this Bear Market as CYCLICAL, the biggest argument is that the American economy (and the World Economy) will not fall into an extended sluggish growth state.
1) Information technology is a fundamental change that brought about the New Economy. This New Economy is characterized by high productivity growth, and quicker volatile cycles. Globalization has further smoothened business cycles and opened great opportunities for domestic firms.
2) Firms have more accurate information and more flexible production and inventory systems which allows them to quickly adjust to changing business conditions. This helps them to cut costs and preserve corporate profits better than before.
3) Although high economic growth rates may not be possible at this time, the economy will continue to recover healthily and consistently, pulling the stock market along with it.
For the believers in the SECULAR Bear Market, current conditions spell out more trouble ahead:
1) Many tech industries are plagued by overcapacity. This creates an environment for a continuous earnings recession. A major wave of mergers and bankruptcies is needed to bring about consolidation.
2) The Kondratieff Long cycle, a model based on long term commodity and equity price fluctuations is indicating that the secular Bear Market is only in its beginning stage.
3) Most investors still live in the past, expecting double digit returns. Analysts like Abby Cohen are just a part of a bigger problem: Complacency and unfounded optimism.
4) Fund outflows are becoming a real drag on the stock market. There is also more stock supply in the form of IPOs and secondary offerings. A weaker dollar will mean more capital flight from the U.S. as Foreign markets become more attractive than domestic.
5) Finally, the P/E for the S&P 500 based on GAAP is now 40, and around 25 on "as reported" basis. That is still high based on historical comparison.
Arguments from both sides are fair. We tend to take the middle ground. If the Kondratieff Long cycle prediction is right, it does not indicate that we are in a SECULAR Bear Market. It means that we will be stuck is a trading range for up to a decade or longer.
We hate to make compromises between the Bulls and the Bears but for now neither argument is convincing enough. This Bear market is our ultimate test. And so far we have done well. We've sold most of our holdings in the period of January through March. Our portfolio is now composed of a Small Cap Value Index and a leader in the defense industry. For now, we have switched the bulk of our activity into trading. By understanding mini-cycles and trends, trading has been making us high returns with little risk." |
