After years, of negative commentary, I promised to lay out the positive case. The promise was lucky because the events of March indicate that we may be looking at a fresh bull market. A major rally or new bull market was widely expected with the opening of hostilities in Iraq. In part that belief rested on the idea that the market and the economy were held up by uncertainty about the situation in Iraq. War is positive by removing the uncertainty. The rally forecast also rested on mirroring off 1991, when the most powerful bull phase in history was launched on the very day the Kuwait War began. In 1991 we had been in a bear market, stocks had rallied off an October low then fallen back, and the economy was in recession. You could not have a more perfect likeness of events. The hangup is that mirroring, while popular and enticing, rarely works out. As we now know, the rally opened five days before the war began, reflecting bullish anxiety to get things going. In only eight trading days the market was up 12%, or about 60% of the total three month first stage bull market rise in 1991. The swiftness reflected the high degree of anticipation, but the move was too big to be sustained. The market then sold off, but the decline was not serious enough to break the upward bias. So far, so good. Despite wide expectation of a rally, investor sentiment indicators were predominantly bearish in early March, which is positive. These surveys have moved up only slightly since the rally began. A considerable swing to bullish sentiment can be expected before the up move is threatened. Technically, the market looks good. We have a triple bottom: a low in August, a slightly lower second bottom in October, and a third higher bottom in early March. This leaves us with a technically strong base extending over five months, and suggests a new bull market, not just a rally. Individual technical indicators are also positive. My most telling directional indicator is daily advances minus declines. Although we hit new lows below those of October on both NASDAQ and ASE, NYSE A/D held. The NASDAQ and ASE are better indicators than NYSE, but A/D is not a good indicator at bottoms anyway. It is terrific at showing a building top, but not a bottom. Overall, a positive showing. Daily new highs and new lows are positive in that new lows at the March bottom were way down from October, when the level was extreme, probably climatic. A nice progression of rising new highs has unfolded as the rally continued. While not useful day to day, high-lows are excellent long term indicators. Aside from sensing a bottom in unusually attractive pricing, the only timely signal I have ever found is a nine to one up volume day. As a new bull market kicks off, one of the early days will have volume on the NYSE for stocks going up that is nine times greater than volume for stocks going down. This is a rare event and indicates such depth and breadth of buying as to create a momentum that lasts for a while. In 1991 we had something like five such days in the first two weeks, but usually only one is required. We had that big volume day on March 17, the fourth day of the rally, and it was an impressive 13 to 1. Follow through on the big mo signal was weak, but the sell off was not too bad considering disappointing news from the front. Another positive factor is time. Bear markets last six months to a year, serious bear markets (say 1973-1974) last at most two years, and even the depression market declined for only two years and ten months. March would have been the third anniversary of this decline, so we were close to setting a record (if the bear market is over, last October will be the bottom). The problem with this analysis is that at the end of the 1929-1932 and 1973-1974 bear markets, stocks were extraordinarily cheap. The foundation of those bottoms was that stocks had gone down as much as they could with values so extreme. Smart money could no longer resist. That is not the case this time. Over the long term, markets work from extremes of valuation at either end. Eventually we are likely to have an outstanding buying opportunity, but it will be hard to see because the economy will look worse than it does today. A somewhat similar positive argument is that the economy must improve. There is no such thing as a double dip, it exists only in government economic data. A double dip recession is merely a longer than usual one. The economy looks terrible now, but only because of the long time we have spent bumping along a bottom. Things always look worst just prior to a pick up. This is not a normal inventory recession, and I suspect things will remain slow for some time, but eventually there will be a pick up. Why not this summer? For the market timer, tops are easy. Bottoms are another matter. The reason market timing is unpopular is not that it can’t be done, but the fear of missing bottoms, and that fear is justified. Bottoms are always hard to call. I use a strategy of going ahead and buying stocks that are extremely cheap and seem to have run out of steam on the downside, knowing there is no way I will be able to call a bottom. The worst that can be said about the market is that if we reached a bottom, it is by far the highest priced in history. The absence of genuinely cheap stocks after such a lengthy bear market will limit gains. Bear markets have always produced attractively priced stocks, and here we have a really big bear market and few bargains. The reason is the extremely depressed level of earnings. If the economy does not bounce back, and fairly strongly, a rally is far more likely than a bull market. Interestingly, many of those looking for a big up move still do not think the bear market is over because of deep rooted economic problems that are either not being addressed or are too intractable for the usual cures, and may be worsened by a deficit getting out of hand. The absence of attractively priced stocks supports that viewpoint. Although I am not yet convinced that the trend has reversed to the upside, the odds are decent that we have seen a bottom. There is no law saying a bear market must produce great value. As to the economy, I don’t believe in basing my investment stance on something so unpredictable. I don’t like that right wing economists see nothing but sunlight despite the clouds, but these people are in control of the government and they may well give us another big tax cut. You have to ask, if the economy really is picking up, why in hell are we going for another tax cut with an exploding deficit (the answer is that the right believes any tax cut any time is a good one). On the other hand, that cut is likely to be positive over the short term. Aside from what is shaping up as a good rally or bull market, the long term picture is not positive for more reasons than high stock prices. I am reminded of a comment by a man who builds his economic theory around historical precedent, a long perspective I much favor, who said, you would have to be crazy to be bullish on the U.S. economy. Our venture into aggressive warfare, the historical curse of leading nations, on top of a loss of interest in fiscal responsibility, has inspired me to begin reading The Decline and Fall of the Roman Empire. But that decline took centuries, and I will be long gone by the time of the fall.
Despite fair strength in recent months, and what appears to be a January effect in the most beaten down stocks, I think the evidence is that the bear market remains in force. If so, in another month the length of the decline will match the 1929-1932 bear market, though it is much milder in severity. That mildness may not be good, for despite the long decline stocks remain high priced. In the spring the bear market would enter its fourth year, which would raise the question, are we in a Japanese style decline, now in its thirteenth year? The situation in Japan supposedly could not happen here because their monetary authorities fiddled while Tokyo burned. In reality, Japan did react, but failed to stem the tide. As to the idea that we would move more decisively, by going along with the speculative boom, the Fed failed when it might have had enough influence to make a difference. Fed inaction is a primary reason we are in this pickle in the first place, and subsequent moves failed to lift the economy, indicating that its influence may have been forfeited. Now the administration is proposing added tax cuts where the major benefits go to the rich, who don’t need stimulus. There is a pattern here - the same kind of inadequate action we criticize the Japanese for. The Japanese seemed to do everything wrong, and we may be following. The recklessness disregard for deficits just might worsen our situation. Has anyone noticed that the dollar is off 25% against the Euro? The few who have claim that is great! But if we defend the dollar, interest rates go up, and if we don’t, there could be a run on the dollar. Our new belligerent foreign policy could add to the pressure. Crazy stock markets, like Japan’s in the late 1980s and ours in the late 1990s, have always been followed by severe declines. When you dig yourself a deep enough hole, it isn’t easy to get out. We are also following the Japanese model in the absence of a severe recession that clears the slate for recovery and prompts more decisive action to help the economy. According to government statistics, we barely had a recession, and the economy advanced all of last year. As I have noted before, there is something fishy about this data, and it has the effect of generating complacency. Far from being cheering, then, the benign economy suggests we are following Japan’s lead. Another similarity is ongoing high stock prices. The Japanese market continued to be recommended for years after the downturn because prices were cheap compared to earlier levels and investors were unwilling to accept that the Japanese miracle had ended. As a result, Japanese stocks remained extraordinarily high when earnings retreated along with prices. The same pattern prevails here, and hope springs eternal because of the belief that somehow our economy is invulnerable. A value myth has been created by the assumption that earnings will quickly return to 1999 levels, even though there is no sign of that happening. A recent earnings rebound is only as measured against 2001 levels that were loaded with inventory and downsizing charges. As for the nuts still buying high technology stocks, they too remind me of the true believers about Japan in that they refuse to face up to the evidence that times have changed. The present tech rally, like the others over the last three years, appears almost orchestrated by traders, rather than based on fundamentals. I suspect that traders start the rallies in hopes of rekindling memories of 1999, and they succeed temporarily as shorts cover and momentum players jump aboard. One of the foremost reasons for thinking the bear market will extend is the recent action of tech stocks. The circumstances that make me believe the bear market is not over fall into three categories: 1) an absence of the kind of give-upsmanship you would expect after such a long decline, 2) the failure of stock prices to reflect the reality of a slower economy and slower growth prospects, and 3) our changed circumstances internationally as reflected in a weak dollar, hatred of the Bush policies all over the world, and diminishing industrial might. We could have a decent rally if the economy picks up a bit, but the great bull market is over, and our circumstances have changed. Ultimately the bear will work its way out, though, either in another severe decline or a lengthy period of relatively flat prices. Most of the best thinkers believe we will have such a flat phase, but that good money can be made, as in the 1975-1981 period preceding the market takeoff in the summer of 1982. However, compared to 1975 there is a serious problem. Then stocks were extraordinarily cheap, today they aren’t. Part of the fast start in 2003 arises from the Bush proposal to make dividends tax free, a move estimated to lift the market 10 to 20%. I would accept that number, and more, if the tax freedom for dividends had gone to corporations, for then they would have been strongly influenced to raise dividends (there is no real influence in the present proposal, other that stockholder pressure), reported earnings would rise meaningfully, and the new system could have been used to straighten out balance sheets. Such a policy would have been highly stimulative, though difficult to pay for without some offset in higher personal taxes, which probably explains why Bush chose short term political expediency and feeding his fat cat friends. As to how much boost the market may get, the S&P-500 yields 1.7% and the overall market less, so a big payoff is unlikely. On a tax adjusted basis, only about ½ of 1% is added to already low dividend income, not enough to make much difference. The very rich with substantial dividends would be a huge beneficiary, but between the low market yield and a goodly portion of dividend payments already being tax free, it is hard to see much boost to the economy. Even conservative economists see little help, other than a better tone for consumer spending out of the assumed rise in the stock market. The Bush proposal is not drawing much support, and he is undoubtedly following a strategy of asking for more than he expects to get, so the plan will be trimmed to a 50% exclusion, or more likely a dollar exclusion like $5,000 to $10,000 (which would get him off the hook about favoring the very rich). While the overall affect is helpful to the stock market, it is not apt to be decisive. The economy is what counts, and at the moment it seems to need more direct help. A bear market, however, is not without hope. For instance, a 1.7% dividend is not enough to lift the overall market much, but far higher payers are out there. Not many stocks yield 4.5% or more, where you get a meaningful plus from a non-tax status, but they are out there. In addition, while stocks in general remain overpriced, low priced special situations have been available all along. These led to our great year in 2001. I blew 2002 by becoming overconfident, but we still suffered only a small decline in a generally terrible year. I am less optimistic than two years ago, however, because extreme bargains were far more numerous then. Still, there are attractive, if not extremely attractive, stocks, and the changing environment will produce special opportunities as the year unfolds. With a little luck, and a better ear for trouble, we could have another good year even if the bear market continues.