By
Steven Vincent
:
The current technical setup in US markets bears striking
resemblance to that which prevailed at the 2011 highs and there are
also some comparisons to the early stages of the 2007-2009 bear
market.
There's a good possibility that the current bear phase that
began in early 2011 is itself a five wave ABCDE triangle and that
we are presently in the C leg down of that formation. This would
allow for a panic bottom similar to the 2010 and 2011 episodes,
followed by a D wave rally spurred by monetary action into a
technically oversold market and then followed by a final E of E
decline, thus ending the long term Bear market that began in 2000.
This would certainly be the resolution that would serve to
frustrate and whipsaw the maximum number of traders and investors,
bullish and bearish alike, for the longest period of time (which as
experienced traders know is the ultimate function of the
market).
At this time there is far too great a bullish consensus on the
part of active market participants to mark an end to the long term
bear market. There is nothing even remotely approximating the
psychology of fear and loathing found at the 1982 bottom at this
time, but there certainly could be with one more good washout
decline. Premature bulls would then exit the market in disgust,
vowing never to return.
There's no doubt that in 1981 many bullish analysts were
confronted with a similar set of circumstances and presented
similar arguments such as we find today. They knew that stocks were
hated, that the public was out, that the economy would eventually
turn, that gloom and doom prevailed. They saw that P/E ratios had
come down well off their highs and had even arguably fallen into
territory that normally marked a buy point. Ultimately, they were
proven right, but not before being wrong for over a year and
25%.
(click to enlarge)
Then, just as now, there were bulls who were just as certain
that a 25% decline could not happen and bears who were certain that
a collapse similar to the period of the Great Depression was
inevitable and unavoidable. The market found a way to prove both
outlooks wrong. Based on my current analysis, I think we will see a
similar resolution this time around as well.
This piece by Doug Short
explains the trouble that many analysts are having when trying to
factor P/E ratio and earnings into their market view. His chart of
Cyclically Adjusted Price Earnings Ratio ((
CAPE
)) shows that while the ratio may be substantially lower at this
time, it is not at lows which correlate with long term bear market
buy points:
(click to enlarge)
Using Robert Shiller's source chart, we can see that, as at the
1976 and 1981 highs, there is certainly room for a final E wave
decline in the ratio:
(click to enlarge)
I might also add that bulls are fond of citing "record earnings"
as a justification for buying into the current market. That seems
to buck common market wisdom. I would be leery of a strategy that
calls for buying at a performance peak, particularly when that peak
has come about primarily as a result of cost cutting rather than
growth.
The following studies indicate that it may be time for an
earnings recession that will accommodate, together with a stock
price decline, a CAPE valuation correction to levels similar to
those seen in 1932 and 1982:
(click to enlarge)
(click to enlarge)
"Disasterist" ultra bears should be cautioned as well. While I
think that the evidence for a significant drop from here far
overwhelms any evidence for a significant rally, Uber Bears are
also likely to be disappointed with the depth and severity of the
decline. Worse, an inability to see the other side of the market
will blind them to the ultimate bottom when and if it should
arrive.
This interview with the former Reagan Administration budget
director is a compelling presentation of the Super Bear case:
Personally, I favor his philosophical outlook and I would prefer
to see his worldview proven correct and see the Keynesian
Monetarist view proven wrong. But wasn't this argument made
throughout the 1970s and early 80s? Haven't we been told that the
fiat monetary system is "unsustainable" for over 40 years? Yet
somehow, some way, the monetary magicians have been able to pull
the proverbial rabbit out of the hat time and time again.
My current sense is that once again, at the end of this cycle,
the funny munny gang will have found some way of extending and
pretending the scheme for another 4-5 years, much to the chagrin of
the sound minded David Stockmans of the world. While it's certainly
far too soon to make any firm projections in this direction, I see
the potential for Dow 18,800 by 2017 which would then, finally,
mark the top of the grand bull cycle that began in 1932. The piper
will be paid, but the bill may not come due for another 5 years or
so.
Disclosure:
I am short [[SPY]].
See also
Modine Manufacturing CEO Discusses F1Q13 Results -
Earnings Call Transcript
on seekingalpha.com