Exploring The Bear Case
By now, just about everybody on the planet knows the key tenets of the bull case. In short, our heroes in horns contend that stocks are discounting better days ahead for the economy, and in turn, earnings, less regulation, a "phenomenal" tax plan, and an economic stimulus package sprinkled in for good measure. And since the all of the above suggest that earnings are going to be better than expectations, stock prices can continue to move higher, we're told.
However, on the other side of the court, the bears too have a case. And while their voices have been quieted by the relentless rise seen over the past four months, our furry friends in the bear camp remind us that there are issues out there that investors will have to deal with - eventually.
Since being able to remain objective is the key to this business, I thought I put my bear hat on this morning and run down the bear argument - in a quick and easy-to-read, executive summary format.
Big-Time Overbought Condition
- The major stock market indices are overbought - very overbought
- One indicator suggests NASDAQ is most overbought since the late 1990's
- This means stocks are "set up" to decline quickly if something negative comes out of the woodwork
Sentiment Is Not Exuberant, But...
- Sentiment indicators have reached extreme levels
- In and of itself, high sentiment readings do not cause market declines
- High sentiment readings simply indicate that most of the money that wanted "in" has likely been spent
- The key to a sentiment "signal" is for the indicators to reach an extreme (check) and then reverse
- Thus, we need to be on the lookout for something to trigger traders to exit the market
Stock Market Indices Are Overvalued
- We've been through this many times and nothing has changed...
- Traditional valuation metrics such as P/E's are currently at very high levels
- Relative valuation metrics (those that compare stock valuations to the level of interest rates) are now neutral - and heading the wrong way
- This is another situation that provides a "set up" for the bears
- But ONLY if they can find a catalyst to get the ball rolling downhill
The Fed Is Tightening
- As the saying goes, "Don't fight the Fed" (especially when they are on a mission)
- Remember, the Fed usually gets what it wants
- The Fed is currently in a tightening phase and will raise rates several times this year
- Historically, this has been negative for stocks
Inflation Is Rising
- Since 2008, the Fed has been trying to avoid a deflationary cycle by attempting to create inflation
- Thus, this time around, the "inflation problem" has been too little inflation, not too much
- But as the saying goes, "Be careful that the solution to the current problem doesn't become your next problem"
- Inflation expectations are rising with our models now very close to the "strong inflation" zone
- Commodity prices have been the driver of the current surge in inflation
- Note: The Core Personal Consumption Expenditures Index (Core PCE) is the Fed's primary inflation gauge
Trees Don't Grow To The Sky
- The market travels in cycles. Bulls morph into bears and vice versa over time.
- Stocks are currently a little over year into a cyclical bull that is occurring within a secular bull trend
- The average duration of cyclical bulls is about 2 years
- The current cyclical bull began on February 11, 2016
- The average gain for cyclical bulls is 106.7% (Source: Ned Davis Research)
Potential For Policy Disappointment
- Despite all the superlatives used to describe the new administration's plans, those plans do have to materialize at some point
- In other words, Trump's policies must turn into economic reality in time - otherwise stocks have been bid up unjustly
- Therefore, there is the potential for disappointment if a purportedly "phenomenal" policy is merely "fantastic" when it actually hits the streets.
So there you have it; my take on the bear case (and for the record, I've probably left out a tenet or two) - in a nutshell. To be sure, there is a "yea, but" to almost every bullet point offered above. But that's not what this exercise is about. No, the goal is to walk a mile in the other guy's shoes every once in a while in order to make sure you understand their view.
Publishing Note: I have an early commitment Wednesday morning and will not publish a morning missive.
Thought For The Day:
"Every minute you are angry you lose 60 seconds of happiness." -- Unknown
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Trump Administration Policies
2. The State of the U.S. Economy
3. The State of U.S. and Global Central Bank Policies
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.
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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.
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