David Kotok of Cumberland Advisors, whom I respect, is one of the veterans making the call that it’s time to ease back in stocks. He makes the case that we’ve just suffered a secular bear market, but government has acted fast enough to avoid a devastating bear. In the interest of making sure you have all the data to make up your own mind, let me show you his view:
He says bear markets fall into three categories: a) Cyclical bears that average 20% to 25% down from peak to trough; b) secular bears that fall 45% to 50% from peak to trough; c) devastating bears that fall 75% to 90% peak to trough, like the Japanese collapse in the 1990s or the current selloff in Chinese stocks. America’s most devastating bear was in the Great Depression, when stocks lost 90% of market value from peak to trough in 1929-1933.
Kotok notes the current 2007-2008 bear market is in the middle category at -45% and adds that “evidence suggests that it is nearly over” with a bottom on October 10th at 7,883 intraday on the Dow Jones Industrials and 839.40 on the S&P 500.
Kotok says the history of postwar bears suggests that these bottoming levels will be retested and may be temporarily breached with the possibility of a new low that doesn’t last long. He says the evidence shows they sometimes end with a climax, while other times they just peter out.
Cyclical bears happen during protracted economic growth cycles, end quickly, and then primary growth trends resume. Secular bears occur when there’s a major economic inflection point and correct major levels of speculation — in this case in debt, real estate and commodities. Devastating bears are extended versions of secular bears that occur when governments fail to counter them with stimulus — in current cases, when China has failed to help its own market, in Japan in the 1990s and in Russia if Putin continues to dismember the market system.
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Kotok further points out that a seminal event usually marks the end of a secular bear and the start of a devastating one. In December 1930, he says, that occurred when the Bank of the United States failed, leaving 500,000 depositors stranded. Hundreds more banks failed, the recession deepened into a recession as credit dried up and unemployment soared.
His view is that nothing on this scale is going to happen, and joins other institutional managers in the view that the limit-down open for the S&P 500 futures on Friday marked a climactic bottom, and that the rate of change in the sell-off has become less negative, with narrowing credit spreads completing the picture. Stimulation speculation.
Moreover he notes that we are witnessing the largest fiscal stimulus in the United States in the postwar era, with a federal debt-to-GDP ratio that will ultimately hit 1.0, a level not seen since World War 2, and Treasury rates near 0%. Since the stimulus should unfreeze credit markets, reverse the home price deterioration and work its way into stocks, in this view, this is the time to get focused on a coming recovery period and move from cash to stocks, corporate bonds and munis.
Kotok concludes by stating that because his analysis suggests we will not have a repeat of the Great Depression, stocks are as cheap now as at the 1987 and 1974 bottoms on a price/earnings and price/book basis, cash on the sideline is at a historic high and sentiment is at a historic low, the eye of the hurricane has passed.
His equity accounts at Cumberland are fully invested in exchange traded funds, and he’s now looking for the S&P 500 to hit 1,700 to 2,000 over the next five years, or more than double.
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I wish Kotok the best, and understand his point of view, yet continue to believe that valuations will overshoot on the downside, leaving a lot of historical comparisons in the dust. I have suggested that the deleveraging process could end up erasing all gains from 1995 to 2007, which would potentially put the Dow at around 4,000 to 5,000.
Calling a bear market bottom here is just an exercise in macho bravado. Kotok and his type may be right, but as chronicled here for months, many others have tried to make the same judgment and paid a steep price. Whoever is right will take credit, but there will be as much luck as skill involved.
And even if Kotok is correct, history and common sense suggest that we’ll see stocks scrape along the bottom for months. I have some great new data that describes the history of waterfall declines amid bear markets, and which sectors tend to do well during basing periods and recoveries, and will share it with you later in the week.Supply still swamping demand
My own observation is that new bull markets are not launched from a standing start. There is virtually always money that creeps stealthily into the market at lows in a measurable way, just as bear markets start when money creeps stealthily away from the market in a measurable way.
The past week featured more 90% downside days, suggesting that sellers are still active. Meanwhile, volume analysts at Lowry’s Reports tell me that there’s little actual evidence that there are enough Kotoks in the market to mark a material rise in buying power.
If prices were so low that a vast majority of investors recognized bargains, buyers would be swarming the market already and sellers would be withdrawing. Yet the reality is that since the October low that many believe marked the final low, demand for stocks has actually contracted while supply has expanded. That’s not a good combination for bulls.
The bottom line is that my discipline calls for us to wait for measurable improvement in demand before exiting our skeptical posture for long-term accounts. The short-term is another story, and to learn how to profit from the volatility, check out my Traders Advantage newsletter.
To learn more about trading in this environment, check out Trader’s Advantage.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.
