Wednesday, February 14, 2007


Guambat is not given to running, so has not been seen running with the bulls. Guambat tends to be a sedentary and non-gregarious soul, and does not consider himself part of any herd. But Guambat will have to ruminate on that possibility in light of the comments from the fund manager who blogs as "Between the Hedges".

Many of the notions about the state of the market Guambat accepts as true are held up to be untrue or speculation by BtH. And, while Guambat stubbornly continues to believe his day will come, the days have already been coming and continue to come for BtH.

If it is reality check time, (see Barry Ritholtz on this: It really matters "how you define your reality . . .") Guambat's check is still in the mail. BtH thinks guambats are in a "negativity bubble".

Here's some snippits of how BtH assays the market in his bullish essay. It's a long and detailed read that requires going to the source.
I continue to believe that steadfastly high bearish sentiment in many quarters is mind-boggling, considering the S&P 500's 19.0% rise in about eight months, one of the best August/September/October runs in U.S. history, the fact that the Dow made another all-time high this week, the macro backdrop for stocks is improving and that we are in the early stages of what is historically a very strong period for U.S. stocks after a midterm election.

I continue to believe this is a direct result of the strong belief by the herd that the U.S. is in a long-term trading range or secular bear environment.

Bears still remain stunningly complacent, in my opinion. The 50-week moving average of the percentage of Bears is 36.8%, a very high level seen during only two other periods since tracking began in the 80s.

Nasdaq and NYSE short interests are very close again to record highs. Moreover, public short interest continues to soar to record levels.

Many of the so-called “bullish” U.S. investors are only "really bullish" on commodity stocks and U.S. companies with substantial emerging markets exposure, not the broad U.S. stock market.

Notwithstanding a 94.4% total return (which is equivalent to a 16.5% average annual return) for the S&P 500 since the October 2002 bottom, its forward p/e has contracted relentlessly and now stands at a very reasonable 15.8. The 20-year average p/e for the S&P 500 is 23.0.

I still believe the coming bullish shift in long-term sentiment with respect to U.S. stocks will result in the "mother of all short-covering rallies."

I do not believe sub-prime woes are nearly large enough or will become large enough to bring down the U.S. economy. As well, the Fed’s Poole said this week that, “there is no danger to the economy from sub-prime loan defaults.”

Home values are more important than stock prices to the average American, but the median home has barely declined in value after a historic run-up, while the S&P 500 has risen 19.0% in just over seven months and 94.4% since the Oct. 4, 2002 bear market low. Americans’ median net worth is still very close to or at record high levels as a result, a fact that is generally unrecognized or minimized by the record number of stock market participants that feel it is in their financial and/or political interests to paint a bleak picture of America.

Energy prices are down significantly, consumer spending remains healthy, unemployment is low by historic standards, interest rates are low, inflation is below average rates, stocks are surging and wages are rising at above-average rates. The economy has created 1.23 million jobs in the last seven months.

Both main consumer confidence readings are now very near cycle highs and many consumers are chomping at the bit to buy new spring clothing after such a warm fall muted holiday clothing sales. I expect new cycle highs for both measures of consumer sentiment over the next few months.

Just take a look at commodity charts, gauges of commodity sentiment and inflows into commodity-related funds over the last couple of years. There has been a historic mania for commodities. That mania is now in the stages of unwinding. The CRB Commodities Index, the main source of inflation fears has declined -9.4% over the last 12 months and -16.5% from May highs despite a historic flood of capital into commodity-related funds and numerous potential upside catalysts.

The commodity mania has pumped air into the current US “negativity bubble.” I continue to believe inflation fears have peaked for this cycle as global economic growth slows to average levels, unit labor costs remain subdued and the mania for commodities continues to reverse course.

I continue to believe oil made a major top last year during the period of historic euphoria surrounding the commodity with prices above $70/bbl. Falling demand growth for oil in emerging market economies, an explosion in alternatives, rising spare production capacity, increasing global refining capacity, the complete debunking of the hugely flawed "peak oil" theory, a firmer U.S. dollar, less demand for gas guzzling vehicles, accelerating non-OPEC production, a reversal of the "contango" in the futures market, a smaller risk premium and essentially full global storage should provide the catalysts for oil to fall to $35 per barrel to $40 per barrel this year.

The US budget deficit is now 1.5% of GDP, well below the 40-year average of 2.3% of GDP. An eventual Fed rate cut should actually boost the dollar as currency speculators anticipate faster US economic activity relative to other developed economies.

In my entire investment career, I have never seen the best “growth” companies in the world priced as cheaply as they are now relative to the broad market. There are very few true "growth" investors even left after six years of underperformance. By contrast, “value” stocks are quite expensive in many cases. Many “value” investors point to the still “low” price/earnings ratios of commodity stocks, notwithstanding their historic price runs over the last few years. However, commodity equities always appear the “cheapest” right before significant price declines.

I continue to believe a chain reaction of events [in emerging markets] has already begun that will result in a substantial increase in demand for US equities.

One of the characteristics of the current US “negativity bubble” is that most potential positives are undermined, downplayed or completely ignored, while almost every potential negative is exaggerated, trumpeted and promptly priced in to stock prices. “Irrational pessimism” by investors has resulted in a dramatic decrease in the supply of stock. Booming merger and acquisition activity is also greatly constricting supply. I suspect accelerating demand for U.S. stocks, combined with shrinking supply, will make for a lethally bullish combination this year.

Considering the overwhelming majority of investment funds failed to meet the S&P 500's 15.8% return last year, I suspect most portfolio managers have a very low threshold of pain this year for falling substantially behind their benchmark once again. The fact that last year the US economy withstood one of the sharpest downturns in the housing market in history and economic growth never dipped below 2% illustrates the underlying strength of the economy as a whole. A stronger US dollar, lower commodity prices, seasonal strength, decelerating inflation readings, a pick-up in consumer spending, lower long-term rates, increased consumer/investor confidence, short-covering, investment manager performance anxiety, rising demand for US stocks and the realization that economic growth is poised to rise around average rates should provide the catalysts for another substantial push higher in the major averages this year as p/e multiples expand significantly. I expect the S&P 500 to return a total of about 17% for the year. "Growth" stocks will likely lead the broad market higher, with the Russell 1000 Growth iShares(IWF) rising a total of 25%. Finally, the ECRI Weekly Leading Index fell slightly this week and is still forecasting modestly accelerating US economic activity.


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