Playing the Bull’s Advocate

08/04/2008 12:00 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

James Stack, president of InvesTech Research, says there are signs we could be close to a bottom in the bear market.

Perhaps we really shouldn't look at this as being devil's advocate, since bull markets are enjoyable and profitable. But here's the bullish case, as convincingly as we can portray it.

This bear could be more mature than it seems. The decline since October has already wiped out 44% of the 2002-2007 bull market's gains. That may be good news, since six of the past eight bear markets ended after bear markets recaptured between 48% and 61% of the previous bull market gains. By that simple standard, we should obviously start looking for a buying opportunity.

At 9 months of age, this bear market is only six months shy of the median bear market of 15 months. And since 1940, the majority of bear markets have ended in 12 months or less. So, again, it might be reasonable to anticipate a possible bear market bottom before year-end.

[Also,] the inflation outlook may not be as bleak as it seems. Up until this point, all news about inflation has been bad. The consumer price index is at a five-year high, and wholesale price inflation is rising even faster.

So, why is [the respected] Economic Cycle Research Institute (ECRI)'s Future Inflation Gauge contradicting both headline inflation and public opinion? The answer, in our simplistic synopsis, is because it's looking past commodity, food, and oil prices.

As in 1979-80 and 1989-90, this gauge was measuring the slowing economy's effect on future inflation. In both instances, it was early-but not wrong.

[And] Sam Stovall, chief investment strategist for Standard & Poor's, asked whether it was historically prudent to start nibbling at bargains once the bear market was recognized. S&P's study was conducted over the past 50+ years from 1956. In nine of the past 12 bear markets, the S&P 500 scored double-digit gains in the 12 months after the 20% decline threshold was crossed.

OK, now that we have your bullish juices flowing, let's step back to inject some words of residual caution. While the economic cheerleaders are out in full force, consumers are not paying attention. In fact, consumer c o n f i d e n c e, as measured by the Conference Board, is at a 16-year low. More ominously, consumer "expectations" just hit a 42-year record low.

In the stock market, valuations are becoming more attractive. The bearish psychological extremes are in place for a market bottom. And we're encouraged by the non-confirmations from the Russell 2000 Index and Nasdaq Index, which did not break under their March lows like the blue chip indexes. Theoretically, we could be very close to a buying opportunity.

However, we are not near a bottom in the housing washout. And until that changes, or until technical evidence of a stock market bottom becomes apparent, we will continue to err on the side of caution.

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