Is the correction in stocks from the April highs almost over? Or is it more than a correction – is it the beginning of a new bear market?The answer depends critically on what you think the economy will do. The idea that we’re going to have a “V-shaped”‘ recovery, so widespread near the top for stocks in April, seems off the table. Now everyone is expecting a “double dip” recession. If that happens, then stocks are headed a lot lower.We never actually had much of a “V-shaped” economic recovery to begin with. So if the economy is headed south from here, it will be ugly. But I really don’t think that’s going to happen.– Don Luskin, “Don’t Worry About The Economy”, Ahead of the Curve, SmartMoney, July 9
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a 24-48 hour delay from time to time. Here is this week’s.
There is a huge debate now raging in the market between the bulls and bears.
For the most part, those who subscribe to fundamental analysis are bullish. And for good reason.
Tuesday afternoon, Intel (INTC) reported “the best quarter in the company’s 42 year history” according to CEO Paul Otellini. Revenues were up 34% from the year ago period and were the highest of any quarter in the company’s history – slightly topping the previous record from the 4th quarter of 2007. Net income of $2.9 billion was up 175% from the year ago period and just below the all-time record from the 4th quarter of 2009.
Further, Intel’s stock appears to be a bargain on the basis of fundamentals. Shares closed at $21.36 today (Wednesday). Intel has about $3 in net cash and short term investments on its balance sheet so you get the business for a little over $18. Over the last four quarters, Intel earned $1.82. Do the math and you get a trailing P/E of 10. That for a leading blue chip company with the dominant market share in its industry.
Monday’s report from railroad operator CSX (CSX) was similarly impressive. Revenues up 22% on a 13% increase in volume and an 8% increase in revenue per unit resulting in a 47% increase in net income from the year ago period.
No wonder the fundamentalists see the recent selloff as a buying opportunity.
Tuesday on his Mad Money show, Jim Cramer went off on the “eggheads” calling for a double dip recession who have probably never even looked at a balance sheet. According to Cramer, these academic economists have no clue and are missing what’s going on on the ground as evidenced by recent company reports. Hedge fund manager Doug Kass went at things from the same angle Monday night on Kudlow & Company. Both were compelling and worth watching.
On the other side are those who are alarmed by the recent market action. Explicitly or implicitly they are technicians. The market action since late April has been dreadful. Even after the recent rally, the S&P at its close Wednesday was off 122 points (10%) from its April 23 closing high. It has broken below both its 50 and 200 day moving averages. Volume is notably higher on down days as compared to up days.
More recently, the S&P’s 50 DMA broke below its 200 DMA in what is known as a “Death Cross”. The last death cross occurred in December 2007 and we all know what ensued after that. Ed Yardeni of Yardeni Research said that every bear market since 1972 has been marked by a death cross (“Dark Omen Threatens Stock-Market Bulls”, Kelly Evans, Ahead of the Tape, The Wall Street Journal, July 1, C1).
That said, the death cross is not a surefire indicator of a coming bear market. In addition to December 2007, it was an accurate indicator in October 2000. But it prematurely signalled the end to the previous two bull markets in July 2006, August 2004, September 1998 and April 1994. To put it in logical terms, a death cross seems to be a necessary but not sufficient condition for a bear market.
Who should we believe?
One of the reasons you haven’t heard from me lately is that I made a cross country trip to Alexandria, VA where I delivered a talk and sat on a panel on the subject of “Ayn Rand and Investing”.
In my talk, I reviewed the two main schools of investing – fundamental and technical – and how each side tends to have disdain for the other. The fundamentalists dismiss technical analysis as voodoo and superstition. The technicians laugh at the fundamentalists for wasting their time on detailed company research they believe has little bearing on stock performance. As usual in most intellectual debates, each side has some part of the truth while mistakenly believing they have the whole.
The fundamentalists appear to be right that companies are showing solid revenue and earnings growth and are attractively valued. (We will find out more about the fundamentals as 2nd quarter earnings come out over the next few weeks). On the other hand, the market action is decidedly bearish.
My own investment philosophy synthesizes the two while adding in Austrian Economics. The core of Austrian Economics is an account of the boom and bust cycle. By understanding where we are in the boom and bust cycle that dominates economic and stock market performance over long periods of time, we are in a position to make better use of the information provided to us by fundamental and technical analysis.
Looking at the macroeconomy, we can see that many large imbalances still exist. Fundamentals based on the previous twelve months are compelling. However, the market is acting the way it is because it is sensing that the policy tailwinds that have propelled the stock market and company fundamentals over that time period are waning. The headwinds from the structural imbalances are beginning to reassert themselves and will condition corporate results going forward (see “Top Gun FP Client Note: Cyclical Tailwinds Versus Secular Headwinds”, Top Gun Financial, June 3). (The current situation has many parallels with the recession of 1937-38 which occurred after four years of economic growth during The Great Depression (for a recent analogy see “Governments Move To Cut Spending, In 1930s Echo”, David Leonhardt, The New York Times, June 30, A1)).
Long secular bull and bear markets have characterized the US stock market and economy at least since the beginning of the 20th century. I have argued many times before that we are in a secular bear market that began in 2000 (see “Top Gun FP Client Note: A Secular Bear Market”, Top Gun FP, July 7, 2009). It will end when the imbalances such as the budget and current account deficits as well as the distortions caused by the Fed’s actions over the last couple of years work themselves out. That won’t happen until policy becomes more responsible or more likely another crisis flushes the system in dramatic fashion creating a stable base on which the economy can build. Until then, the upside is limited.
The 2nd quarter ended two weeks ago and here are the performance numbers:
DJ Total: -11.60%
Top Gun: -2.61%
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