munKNEE.com Your Key to Making Money
The current U.S. equity market has something for everyone. Whether you are bullish or bearish, there is no
shortage of indicators or charts you can use to support your thesis. Let’s run through both the Bull and the Bear case here.
The above are edited excerpts from an article* by Charlie Bilello, Director of Research (pensionpartners.com) entitled What’s Your Confirmation Bias?
The following article is presented by Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and the FREE Market Intelligence Report newsletter (sample here; register here) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
Bilello goes on to say in further edited excerpts:
The Bull Case
1. The Economy
Bull Thesis: The economic expansion remains intact.
- Unemployment Rate at cycle lows (6.3%).
- US Manufacturing steadily improving over past few months (last reading: 54.9).
- Jobless claims at new cycle lows (297k), back to 2007 levels.
2. The Fed
Bull Thesis: With the Bernanke/Yellen “Put” still firmly in place, “don’t fight the fed.” Tapering ≠ tightening and even if the Fed continues with its QE reduction they will still keep rates at “exceptionally low” levels for a long, long time.
- Over 5 years of zero interest rate policy (ZIRP) and a Fed balance sheet of over $4 trillion. S&P 500 up 185% over that time so the two must be closely related.
3. Valuation
Bull Thesis: Stocks are cheap and nowhere near the bubble valuations early 2000. The S&P is trading at only 18.6x TTM earnings and 13x 2015 expected earnings. With interest rates near historic lows and earnings at new all-time highs, P/Es should be much higher. If we assume only a 15x multiple on next year’s expected earnings ($144), we get to 2160 on the S&P 500, or 15% above current levels.
- Earnings are at new highs and growth is expected to be strong next year. Earnings drive stock prices.
4. Credit Markets
Bull Thesis: Credit markets remain strong with junk bonds at new all-time highs. This is good sign for the economy (companies have easy access to credit) and as credit typically leads, it should be good for the stock market as well. Low yields in general make equities the more attractive asset class.
- Bank of America-Merrill Lynch High Yield Master II at new highs. Ditto the HYG & JNK ETFs.
5. Market Action
Bull Thesis: The S&P 500 is at all-time highs. New all-time highs are bullish. The “trend is your friend” and the trend is still up.
- The S&P 500 since early 2013. A low volatility, smooth advance and the market quickly recovers from any minor dip.
- The NYSE Advance-Decline line is at new highs, an indication of strong breadth and further gains to come.
6. Sentiment
Bull Thesis: The wall of worry persists which is contrarily bullish. This has been the most hated bull market in history and until more investors come back in, the market will go higher.
- Despite new all-time highs last week, the CNN Fear & Greed Index is showing a reading of “Extreme Fear.”
7. Seasonality
Bull Thesis: Seasonality is bullish from here until early September.
- On average, the annual cycle for the S&P 500 shows a bottom in late May and rallies until early September.
The Bear Case
1. The Economy
Bear Thesis: The economic expansion is long in the tooth. It will reach 60 months this June versus an average post-war expansion of 58 months. Signs of a slowdown are beginning to emerge.
- Economic growth has come to a standstill, with real GDP at 0.1% last quarter.
- An important part of the economy, Housing, is weakening. The Housing Market Index has moved down to 45, its worst level over the past year and Existing Home Sales have contracted in 7 out of the last 8 months.
2. The Fed
Bear Thesis: Quantitative Easing (QE) and zero interest rate policy are no longer helping the economy and the Fed knows this and wants out. The last two times we saw the Fed end QE programs were followed by significant market corrections. Japan has also proven over the past year that endless QE does not necessarily mean stocks only go up.
- In 2010 and 2011, the S&P 500 saw 17% and 21% corrections following the end of QE. With the Fed set to end this round of QE in October, will market participants wait for QE to end or start selling in advance?
- In spite of endless QE and no tapering in Japan, the Nikkei is down over the past year and down -13% in 2014.
3. Valuation
Bear Thesis: Stocks are overvalued. If you look at metrics like the Shiller P/E, it shows that the S&P 500 is currently trading at a higher valuation than 92% of other times in history. At the current level above 25, it is predicting lower equity returns going forward.
- The Shiller P/E has only been higher in a few other time periods in history. All of these time periods were followed by weak returns looking out over the next 7-10 years.
4. Credit Markets
Bear Thesis: The Treasury market is warning of a slowdown in the economy. In the fifth year of an expansion, you should not be seeing long duration bond yields falling as they have persistently throughout this year. As bond investors are the “smart money,” this is negative for equities.
- The 30-Year yield has moved down from close to 4% at the start of the year to 3.3% currently.
5. Market Action
Bear Thesis: The trend is extended and the market is tired. There hasn’t been a real correction in almost 2 years and we are long overdue. Underlying weakness is widespread with small caps, growth stocks, cyclicals (especially Consumer Discretionary), and housing stocks underperforming.
- The S&P 500 has gone 376 trading days without a cross below its 200-day moving average.
- The Russell 2000 is down over 10% from its early March peak and has given up all of its 2013 relative outperformance versus the S&P 500.
- This is the most persistent weakness in the Consumer Discretionary sector that we have seen since the Bull Market began in March 2009. Similar weakness was seen in 2000 and 2007.
- Homebuilder stocks are telling a very different story than the S&P 500.
6. Sentiment
Bear Thesis: With the stock market at all-time highs, complacency is high. These extreme bullish levels of sentiment are often followed by below average returns going forward. The market needs a correction to “refresh the fear.”
- Bulls (55.1%) outnumber Bears (19.4%) by 35% in the Investors Intelligence poll, a historically high level of optimism.
- The VIX is at the low end of its historical range.
7. Seasonality
Bear Thesis: Sell in May and go away. It is Year 2 of an election cycle and we are in the most bearish part of the 4-year cycle.
- Year 2 of the election cycle is typically weak from May through early October.
What’s your Confirmation Bias?
Depending on your current positioning, you were more likely to focus on and agree with either the Bull or the Bear case. This is the essence of Confirmation Bias and as humans we are all inherently biased in this way. Where this can be problematic for investors is when they exclusively seek out information that supports their view, leading to suboptimal investment decisions when they are on the wrong side of the trade.
Examples are not hard to come by.
- We all know of Bears who have remained stubbornly bearish over the past five years, and have done so by only reading bearish-leanings publications.
- Those with a longer memory will also recall the many Bulls that remained bullish from the 2007 top to the 2009 low by only seeking out bullish-leaning publications.
For our part, having a quantitative process helps us in avoiding the perils of Confirmation Bias. Being a tactical manager also helps in that we are not wedded to a permanently bullish or bearish view. This makes more sense in our view as the markets and relative attractiveness of different asset classes are constantly changing.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://pensionpartners.com/blog/?m=201405; © 2014 Pension Partners, LLC – All Rights Reserved. (This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.)
Related Articles:
The Bears:
1. Extreme Greed By the Crowd Suggests You Show Some Fear! Here’s Why
Greed may have been good for Gordon Gekko. but in the investment world it rarely is. As Warren Buffett is famous for saying “…be fearful when others are greedy and greedy when others are fearful” [and now is such a time]…to start showing some level of fear here in the face of extreme greed by the crowd. The crowd can be right for a long time, but they are rarely right at extremes. While this time may be different, the probabilities suggest that at the very least it will be a more difficult environment for equities going forward.
2. Make No Mistake – A Major Stock Sell-off Looms! Here Are 4 Ominous Signs
The 4 fundamentals and technicals discussed in this article accurately called stock market crashes in 2000 and 2007 and these same market metrics are again TODAY warning that a possible financial tsunami is brewing on the horizon. No one knows for certain WHEN the tsunami will hit Wall Street…but, without question, today’s stocks exhibit extremely exaggerated valuations, and extremes never last, so make no mistake, a major stock sell-off looms.
3. These Indicators Should Scare the Hell Out of Anyone With A Stock Portfolio
For US stocks — and by implication most other equity markets — the danger signals are piling up to the point where a case can be made that the end is, at last, near. Take a look at these examples of indicators that should scare the hell out of anyone with a big stock portfolio.
4. Remember the “Nifty 50”? It’s Back! What Does It Means For the Markets Going Forward?
Market historians will recall the term “Nifty 50” originated in the 1960’s bull market to describe 50 wildly popular large-cap stocks at the time. Interestingly, some of the same names from that list are leading the market higher today. The question for investors, of course, is what this selective advance means for the markets going forward.
5. Are We In Phase 3 – the Final Phase – of This Bull Market Yet?
Are we in the third phase of a bull market? Most who will read this article will immediately say “no” but isn’t that what was always believed during the “mania” phase of every previous bull market cycle? With the current bull market now stretching into its sixth year; it seems appropriate to review the three very distinct phases of historical bull market cycles. Read More »
6. Is Now the Calm Before the Storm?
I’d argue that the record low volume shows investors aren’t looking ahead as much as looking behind and reminiscing at how good things have been over the past five years or so. They’re expecting more of the same even though it’s mathematically impossible people. Read More »
7. Should You Care What’s Happening On the Nikkei 225? YES! Here’s Why
Should markets around the world really care about what the Nikkei 225 Index does? The Power of the Pattern suggests “yes”! Here’s why. Read More »
8. Collapse of S&P 500 May Be Only Weeks Ahead! Here’s Why
When Staple sector (i.e. defensive) stocks started to reflect greater relative strength than Discretionary sector stocks back in 2000 and again in 2007, the S&P 500 began to fall dramatically in the ensuing months. That’s happening again. Can a collapse of the S&P 500 be far behind? Read More »
9. There’s Evidence – Plenty of It – That the Bear Is No Longer Hibernating. Here’s Why
The health of a market is best assessed along three vectors: fundamentals, technicals (price action) and sentiment and this is what each is saying about the health of the markets these days. Read More »
10. A 20%+ Sell-off is Brewing In the Lofty U.S. Stock Markets – Here’s Why & What the Future Holds
For today’s seriously overextended and overvalued US stock markets the best-case scenario is a full-blown correction approaching 20% emerging soon while the worst case is a new cyclical bear market that ultimately leads to catastrophic 50% losses. Read More »
11. Margin Debt: It Doesn’t Matter ’til It Matters! Is Now the Time to Be Worried About the S&P 500?
It doesn’t matter until it matters! IF margin debt should start decreasing swiftly, history would suggest something different is taking place in the mind of aggressive investors. Will a decline in margin debt from all-time highs matter this time? Read More »
12. 2 Stock Market Indicators Are Saying “Be careful, don’t get caught up in the euphoria”
In the midst of all the optimism we see towards key stock indices these days, there are two leading indicators that are flashing warning signals. They say, “Be careful, and don’t get caught up in the euphoria.” Read More »
13. Beginnings of Massive Stock Market Correction Developing: Don’t Delay, Prepare Today!
No stock can resist gravity forever. What goes up must eventually come down. This is especially true for stock prices that become grotesquely distorted. We have been – and still are – living in another dotcom bubble, and – like the last one – it is inevitable that it is going to burst. Read More »
14. 3 Historically Proven Market Indicators Warn of an Impending Market Top
It’s frustrating to see key stock indices keep pushing higher when historically proven market indicators are all warning of a crash ahead. Irrationality is exuberant to say the very least, and that’s why I believe this rally is counting its last days. Read More »
15. The Stock Market Is a Risky Place to Be – Here’s Why
With both the fundamentals and the technicals saying the stock market is a risky place to be, we await its crash back to reality. Here’s why. Read More »
The Bulls:
1. Relax! The Stock Market Is Anything But “Scary-Overvalued” – Here’s Why
Are we near the end of one of history’s great stock market rallies? I don’t think so. Yes, prices are in the upper half of their long-term trends, but it’s not what you might call “scary-overvalued.” There is still plenty of room on the upside before historical precedents are violated. Let me explain further. Read More »
2. No Problems Foreseen – Yet – from Sky Rocketing Margin Debt BUT
Is the latest credit-balance trough a definitive warning for U.S. equities? In this article we examine the numbers and study the relationship between margin debt and the market, using the S&P 500 as the surrogate for the latter. Read More »
Last year’s “Sell in May” period was only the third time since the turn of the century that stocks have postedstockcrash-2 double-digit gains from May through October so, with stocks still near all-time highs as the calendar flips to May, do the law of averages suggest we’re on the brink of a major pullback over the next six months? Read More »
4. This Chart of the Dow Suggests “Bring on 2014 – We Ain’t Seen Nothin’ Yet!”
The Dow is up almost 28% but the chart below showing how it’s 12% annualized gain over the past 5-years compares with past bull markets suggest we are probably not at a top – that “We ain’t seen nothin’ yet!” Take a look. Read More »
5. Don’t Be Scared “Stockless”! There’s No Fear Anymore – Anywhere!
There’s no fear anymore – anywhere – and I’m talking about the type of fear that overwhelms investors – and, in turn, the market. The surest indication of this can be found in the following chart. Read More »
6. Stocks to Continue to Soar & Gold to Continue to Fall in 2014 – Here’s Why
Each December we publish a list of investment themes that we feel are critical to the coming year. Below are our expectations for the U.S, Japanese and European stock markets, municipal bonds and gold. Read More »
7. Relax! Take Stock Market Bubble Warnings With a Grain of Salt – Here’s Why
Bubble predictions are headline-grabbing claims that are sure to attract reader/viewership and more than a few worried individuals who will be pushed to act but, like all forecasts, these bubble warnings should be taken with a grain of salt. Read More »
8. Grantham: No Market Bubble for a While – But It’s Coming!
I would think that we are probably in the slow build-up to something interesting – a badly overpriced market and bubble conditions. My personal guess is that the U.S. market, especially the non-blue chips, will work its way higher, perhaps by 20% to 30% in the next year or, more likely, two years, with the rest of the world including emerging market equities covering even more ground in at least a partial catch-up. Read More »
9. Stock Market Bubble & Coming Recession? These Charts Say Otherwise
The real value of the stock market is positively correlated, over time, with the amount of freight hauled by the nation’s trucks (in other words, the physical size of the economy has a lot to do with the real, inflation-adjusted value of the economy) and the latest numbers (see chart) strongly suggest that we are not in a stock market bubble. Read More »
