Monday, October 11, 2010

The Bullish Case

If you are feeling skeptical and concerned about the economy and the stock market, don’t worry. You have plenty of company…unless you are an institutional investor who is being whipsawed between bearishness and bullishness from month to month. You should know that if by the end of this missive you don’t believe the bullish case I’m making then most professional investors would say your view is bullish for equity markets, since bull markets “climb a wall of worry.” In this case, you are a “retail” worrier so your skepticism is as bullish as any bull could want. Please keep in mind that the following bullish case is made within a secular bear market, which means that the market will go up…until it comes down again as the secular bear market grinds on. Bulls think the market should move higher from here because basically….the fix is in.

The worst of the economic downturn is behind us. Leading economic indicators have rallied from their lows, and while some are flattening out, they still are greatly improved from the downturn in 2008. Double dip recessions are exceedingly rare, and there is no historical evidence that the economy should downshift in the face of massive additional monetary and fiscal stimulus. Make no mistake…if the recent lousy economic numbers continue the Fed will act with another $1 trillion or so of monetary stimulus. The bullish bet is that the additional money will either stimulate the economy and get the virtuous growth cycle kick-started resulting in higher employment, stabilized housing prices, higher capacity utilization, more bank lending, etc., which will result in higher stock prices. Or, the additional $1 trillion will do none of the above, but will find its way into the stock market nonetheless, driving stock prices higher. Bullish investors see this as either a virtuous return of price inflation or a non-virtuous return of asset inflation. Either way…happy days! By the way, the last cyclical bull in a secular bear lasted for exactly five years, from October of 2002 to October of 2007. It turned out that the entire bull market was built on smoke and mirrors, but who cares? By that measure we have at least another three years to enjoy the current cyclical bull.

The world is indeed different in the post-Lehman, flash crash, over-indebted place we now inhabit. It is the emerging markets of China, India, and Brazil that will lead the global economy out of recession. Unlike the U.S., Japan, and Europe, where the sovereigns essentially brought nothing but bogus debt onto their balance sheets, the balance sheets of the emerging countries look pristine. For that matter, on a relative basis, so do the balance sheets of blue chip U.S. companies that earn a large percentage of their profits overseas. Bonds might be horribly overvalued…you can currently lend the U.S. government money for 10 years at 2.4% interest. The Fed has pegged the Fed Funds rate at 0%! Cash pays nothing. So liquidity is flowing to emerging markets and commodities. Once we get a few more months of higher U.S. equity prices, then you, dear reader, will be clamoring for more U.S. stocks as well. Corporate earnings have been booming as productivity growth continues to surprise to the upside. So, the market is cheap and is likely to go higher. We are entering the most bullish seasonal time of the year and seem to be dodging the September-October blues. And the third year of presidential terms has a great track record for bullish stock market results. So there you have it....I told you you wouldn’t believe me!