Frankly, I am having a hard time being bullish because everything feels so bad.
I was in the office on President's Day and watched the S&P 500 futures tick down to near-term support at 806, such that futures are indicating a 20 point decline at the open on Tuesday. Now, it appears the market has formed a short-term double-top, and with stocks continuing to reach lower highs, it feels like we are about to break to the downside and re-test the November lows.
Emotionally, selling feels like the right thing to do. However, cerebrally, since I have a time frame longer than my nose, there are many reasons not to sell at these levels, and to in fact buy stocks. But it is difficult not to walk away in disgust, especially after last week's action, which was just horrible.
Everyone knows why you should be bearish - the credit crunch continues, the economy is terrible and earnings estimates continue to come down. The reasons to hate stocks are very well known. So I made a list of reasons why stocks could be substantially higher within the next year or so.
- Credit spreads have improved. Credit remains tight, but spreads have come in. Over the past 50 years, the average gain to stocks has been 18% when credit spreads are falling.
- Cash spreads are improving. The TED spread and swap spreads are at levels last seen before the crisis began last fall.
- Treasuries are backing up and yields are rising. The bond market has experienced a violent sell-off in the long end of the curve, while short-term T-bills - which were yielding negative returns a few months ago - have seen rising yields.
- The yield curve is steep. When the curve is this steep, it almost always signal economic expansion over the next 12 months.
- Corporations issued the highest volume of debt in January than in any month since May. In fact, debt issuance was greater than the last four months of 2008 combined.
- The dollar may be topping. Some may argue that this is because of all the debt that the Treasury will flood onto the market. However, a rising dollar has also been indicative of fear and a flight to safety. A falling dollar may indicate that fear is seeping out of the market.
- The euro/yen cross has been moving sideways for months and may be basing. The euro/yen carry trade had been popular over the past several years as investors bought higher-yielding euro-denominated bonds and financed the purchases by borrowing in lower-yielding yen. This carry trade has been seen as a proxy for risk appetite in the global capital markets. It may be signaling that investors are becoming less fearful.
- The gold/silver ratio has fallen below 70. The ratio was as high as 80 a few months ago. Both gold and silver have been rising the past few months, but silver has been rising faster than gold. From September through November, silver fell 30% to the trough whereas gold fell 10%. Silver is a thinner market but it is also an industrial metal and more exposed to the general economy than gold. Gold is a haven during crises. Silver prices rising faster than gold prices may be signaling that the economy is going to get better in the future and/or investors are less fearful about financial markets.
- Metal prices may be bottoming. Though it is still early, a bottom in stocks is sometimes presaged by a bottom in metals and commodity prices.
- Commodities may be bottoming. Oil may be putting in a bottom as well.
- Canadian stocks may be bottoming. Energy and metals comprise roughly half of the total market capitalization of the Toronto Stock Exchange. Materials stocks in Canada have been performing fairly well.
- Chinese stocks may be bottoming. Stocks in China have been acting well as of late. I am long the FXI.
- Semiconductor stocks have been outperforming and may be in the beginning of an uptrend. Semiconductors are often an early indicator of the health of the technology industry. I am long a basket of semiconductor and semiconductor equipment stocks.
- The VIX is acting like it wants to break below 40. On Thursday's intra-day reversal, the VIX closed sharply down. On Friday, when the market sold off during the last 20 minutes of the day, the VIX gave up less than half the decline of the prior session. This may be a sign that investors are getting more confident of the future.
- Asset allocation by individuals towards equities is at or near all-time lows whereas allocations towards cash is at or near all-time highs. The public is generally positioned like this at bottoms.
- Cash levels are at multi-decade highs. There is nearly $9 trillion in cash on the sidelines currently.
- Hedge funds are heavily in cash. There are very few hedge funds that are bullish now.
- Private equity investors are sitting on their hands. After incurring large losses in their portfolios and wary of the cash crunch of their limited partners, private equity funds are doing little. It seems that everyone is waiting for a turn before investing.
- Everybody whom I talk to is negative. I have had in depth discussions with two dozen highly knowledgeable investors this month, and they are all overwhelmingly and uniformly bearish. Every. Single. One. Even those who are buying because they see value in the market are bearish on the market and the economy as a whole. I had to talk a friend and a 20-year veteran of the business off the proverbial window ledge last week.
- Reversion to the mean suggests at least a bounce. Last year was one of the worst years on record. Tremendous selling usually begets a significant rally.
- Stocks are cheap. Whether you want to measure by the 10-year moving average of earnings, Tobin's Q, or measures of book, sales and normalized earnings, stocks are inexpensive.
Now, as I tell you all this, I think there is a fairly good chance - 60% or 70% perhaps - that the market is about to re-test the lows over the next week or two.
Even after I listed all those points above, I cannot tell you that I feel bullish.
Maybe that is a sign a bottom is near.