The Bullish Case Against S&P Bedlam

by Marc Bastow | August 15, 2012 8:30 am

So, the S&P 500 has taken a breather after an orderly seven-day run that brought the index over the magical 1,400 mark, and both the S&P and the Dow Jones Industrial Average have ridden a summer rally that has them at least flirting with 52-week highs.

Not good enough for Morgan Stanley (NYSE:MS[1]). It appears MS analyst Adam Parker is sticking with his prediction of a bear run[2] that would end at around 1,167 on the S&P — a drop of around 17% from this morning’s level.

The gist of his call is based on four assumptions:

  1. Weak earnings are actually being under-reported and under-represented, and will continue.
  2. The reality of the “Fiscal Cliff” is being ignored and represents a huge macroeconomic risk.
  3. Interest in U.S. equities has grown as emerging-market growth has slowed, but too far, and emerging-market stocks will become en vogue again.
  4. Cash-hoarding companies have no stomach to deploy the money, and net debt is on the uptick.

Well, I don’t know. Each point is valid to an extent, but not all the way. Which means while I can see a pullback — which seems to happen every time European leaders sneeze, the Fed balks at stimulus or another economic indicator backslides even a fraction — a 20% drop by year’s end is out there.

Here’s why:

Earnings are all over the place, just like they always are and will be. It is the nature of the beast — some companies do well while others don’t, plain and simple.

Still, colleague Dan Burrows is on Parker’s side[3] on this one, and he lays out a very nice case to back up his sentiment. I don’t disagree, and I too am concerned about guidance numbers that appear to suggest an earnings slowdown. But I also believe corporate chieftains are gun-shy about providing even the slightest hint of optimism given the beating they take when they miss analyst estimates. Methinks they doth hedge too much. Savvy investors who do the homework will know the difference.

The “Fiscal Cliff” is an unknown quantity because nobody really knows what the full extent of any “mandated” cuts will be, or where they will fall. Defense stocks should be the first ones to feel the pain, as the rules of the road indicate their programs will be gutted[4]; yet names like Lockheed Martin (NYSE:LMT[5]) and Northrop Grumman (NYSE:NOC[6]) are trading near multi-year highs.

Regardless of who wins the November presidential election, Congress is unlikely (never say never) to get to Jan. 1 without some kind of plan. Few Congressmen will want to report back at the Christmas break that they wanted the cuts to take hold in a “weak” or “mildly recovering” economy.

Before the pendulum swings back toward emerging markets, investors will need a reason. There’s more news than bad coming out of China — frankly, I’m never quite sure whether the economic data coming out of the country is fully valid anyway — and even Premier Wen Jiabao has expressed concerns[7]. India, a less-hyped but still enormous emerging market, also continues to suffer setbacks.

South America has growth prospects, too, but its biggest representative, Brazil, has its own case of the hiccups. Africa is growing, but there’s few vehicles for investment there. InvestorPlace Editor Jeff Reeves likes a number of Australian companies[8], but the country is tightly chained to China — which holds negative consequences as long as the Chinese coin keeps coming up tails — and it also has consumer debt and a potential housing bubble to deal with.

Cash sits on company balance sheets because it has no better place to go. CEOs hoard cash because they don’t want to pay for new plants, equipment and people if they don’t see a payoff (simple Finance 101 concept), or they don’t see any vertical markets in which to invest without risk (simple Economics 101 concept), or dividend increases[9] are feared by those saving for a rainy day (simple Psychology 101 concept).

Until proven otherwise, cash is king, and companies are interested in using it to strengthen the balance sheet. What’s interesting is that the smart guys are tapping into low-cost debt just to raise more cheap cash. The big boys are well-capitalized, liquid and ready to go on a moment’s notice. Sure, I want my dividends[10], but I can’t argue with their strategy.

So, a pullback from S&P 1,400? Sure, it could happen. Probably will. But a 20% drop by New Year’s? I think not … and I certainly hope not. Like most things in life, the truth probably lies somewhere in the middle. A more modest pullback of 8%-10% doesn’t sound appetizing, but reasonable.

Marc Bastow is an Assistant Editor at As of this writing, he did not hold a position in any of the aforementioned securities.

  1. MS:
  2. sticking with his prediction of a bear run:
  3. on Parker’s side:
  4. their programs will be gutted:
  5. LMT:
  6. NOC:
  7. has expressed concerns:
  8. likes a number of Australian companies:
  9. dividend increases:
  10. I want my dividends:

Source URL:
Short URL: