Bearing with Bulls

You're probably getting the message we're unabashedly bullish at MarketMinder this year. We see no evidence the "credit crunch" signals systemic problems (see MarketMinder commentary "Credit Crisis Conundrum" 07/12/2007). We're well-assured current market activity is characteristic of a normal bull market correction ("Pray for Panic" 08/10/2007) and continue to believe now's an outstanding time to own and buy stocks. Hooray!

But never call us perma-bulls. Yes, we're far more likely to be bullish than bearish at any point in time—markets are positive about 70% of the time. But sometimes, strategic bearishness is appropriate. By "strategic" we don't mean dancing around short-term volatility, such as we're experiencing now. In our view, bearishness is only appropriate in anticipation of a true bear market—a prolonged downturn over the next 12 months or so. (For more on why timing corrections is a bad idea, read "Corrective Measures" 08/03/2007.) So what would it take to make us bearish?

First, you have to have some huge, negative set of fundamentals that are largely unnoticed or underappreciated. This means current credit market hysteria is out as a bearish driver. Why? It's not as major as many believe. Subprime losses are estimated to be about $35 billion currently—tops. Seems like a huge number in absolute terms, but according to the following article, it's "equivalent to a stock market decline of about 0.2%," i.e., wholly irrelevant.

Federal Reserve Policy Actions in August 2007: Frequently Asked Questions
By Stephen Cecchetti, Vox
https://www.voxeu.org/index.php?q=node/460

The subprime fallout is not a major negative, but it's also too well known. We've been agonizing over subprime the entire year. Whatever minimal impact it could have on the market has long been reflected in current market prices. The market action we're seeing lately is not based on fundamentals—it's pure emotion.

Second, once you've identified a set of little-noticed negative fundamentals, there must be euphoric sentiment, similar to what we saw in the outset of 2000—when "earnings didn't matter" and it was a "new paradigm." BusinessWeek called it a "new economy" in this January 31, 2000 cover article:

The New Economy
Michael J. Mandel, BusinessWeek
https://www.businessweek.com/2000/00_05/b3666002.htm

Hindsight makes it a laugh riot now, but it perfectly reflected the time's sentiment. We see nothing like euphoria now. Quite the opposite, actually, given how many times the word "Armageddon" has been tossed around lately.

That doesn't mean we don't think negative fundamentals can't develop. High on our watch list currently is aggressive legislation—something like major new laws aimed at "fixing" subprime by blocking issuance of high-yield debt. Though Congress is clucking convincingly, it's unlikely such legislation would make it out of committee. Even if it did, it likely won't get past President Bush's veto pen.

Another bearish development would be erection of trade barriers (see MarketMinder commentary "Free Trade Imperiled" 08/08/2007). Though certain Senators are currying union favor by disparaging globalization, we doubt even the most narcissistic Senator would commit economic seppuku. We imagine any aggressive trade barrier legislation making it out of committee would be squelched with two words. Smoot. Hawley.

What else? A major central banking policy error could definitely turn us bearish, like sudden and aggressive tightening—though this is perhaps the least likely scenario. We find the Fed's recent actions to be perfectly normal and not alarming. The media has made much of the Fed and the ECB injecting cash into the system, but this doesn't portend anything ominous. It's simply a central bank doing one of its core functions—managing liquidity (see "Blood in the Alleys" 08/09/2007).

But should all that happen, unlikely as it is, we still don't sense any euphoria. Sure, that could change too, but it seems unlikely from this vantage point. For now, the best course is to remain disciplined and expect more near-term volatility. It feels terrible but won't hurt you (unless you do something dreadful like selling at the absolute worst time and missing the recovery). We remain bullish—just not perma-bullish.