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Beware of “Armageddon Hypochondria”
03/24/2011 12:08 pm EST
Sure, we’ve had an eventful few years, but the market seems to be overreacting to every unexpected event that comes its way. In truth, it looks like we have a solid, self-sustaining bull market on our hands, says MoneyShow.com editor-at-large Howard R. Gold.
If you blinked, you may have missed the latest correction.
After its recent peak of 1,343 on February 18, the S&P 500 index plunged when the popular uprisings that swept Egypt and Tunisia spread to oil-producing Libya, driving prices of Brent crude oil near $120 a barrel.
Then came the giant earthquake and tsunami in Japan, followed by a dangerous accident at the Fukushima Daiichi nuclear power plant 140 miles northeast of Tokyo—a situation that is still unsettled nearly two weeks since the disaster took place.
Now, the US, the UK, France, and other western powers have installed a United Nations-authorized “no-fly” zone in Libya, ostensibly to keep Muammar “Madman” Gaddafi from slaughtering rebels in the eastern city of Benghazi.
Saudi Arabia is pumping extra oil to cover Libya’s shortfall, and its government is trying to remove neighboring Yemen’s unpopular ruler while simultaneously crushing a Shi’a-dominated revolt in Bahrain.
Meanwhile, Tokyo Electric Power has made some progress in containing the second-worst nuclear accident after Chernobyl, amid warnings of higher radioactivity levels in Tokyo’s drinking water.
The S&P, which fell 6.4% from its peak at one point, is now roughly 3% off its February highs. The VIX index, the market’s fear barometer—which spiked above 30 recently—was back under 20 Wednesday.
The market may tumble again tomorrow or next week—and the fall of Portugal’s government brings the European debt crisis front-and-center again. But the current mini-crisis may well be over.
The Market Cries Wolf
Regardless, it follows a pattern we’ve seen many times: The market has a big run, investors get complacent, then unexpected events throw everyone for a loop, and fear takes over.
It happened with Greece last year. Several months later, the market took off and kept rising until the latest panic began.
James W. Paulsen, chief investment strategist at Wells Capital Management, dubbed the phenomenon “Armageddon hypochondria,” fear that the end of the world—or at least another market crash—is nigh.
Investors were traumatized by the bear market and financial crisis of 2007-2009, he explained to me in an interview. “All we’ve been doing for the past two years is looking around and trying to see what will be the next crisis,” he said.
That has led people to blow small- or medium-sized crises into full-fledged global catastrophes, with the assistance of the 24/7 media (including this humble commentator). Investors become paralyzed, can’t decide whether to buy, hold, or sell, and so throw up their hands and do nothing.
That’s too bad, because if you really looked closely, the recent events—while significant—were not enough to derail what is shaping up as at least a normal cyclical recovery and bull market, and maybe even more.
First of all, the recent upheaval in the Middle East and North Africa was not enough to disrupt oil production and send crude prices to levels at which they would cripple the global economy. Libya, and even Algeria, could go mostly off-line without squeezing supply too much, as long as Saudi Arabia continued to pump oil.
So, the only important question for investors was whether the Arab revolution would overthrow the House of Saud. If that happened, it would be more monumental than the fall of the shah during the Iranian revolution of 1979, which caused oil prices to triple and bond yields to soar.
But the Saudi royal family looks more resilient than other leaders in the region, and there’s no clear and present danger to their survival.
Next: What We Really Need to Worry About|pagebreak|
What We Really Need to Worry About
And then there’s Japan. Now the third largest economy in the world, Japan is a key part of the global supply chain.
The earthquake and tsunami disrupted that, and manufacturers of products as diverse as automobiles and semiconductors have scrambled to find new suppliers. They will, but it will take time, and by then most Japanese facilities should be back online.
As for the troubled reactor, without a massive spread of radiation to Tokyo and major population centers in Asia, which appears unlikely now, this will be a black swan event with mainly regional and industry-related consequences.
So, neither of these events would be able to unravel the bull market.
Here’s what we really have to worry about. In the past, Paulsen told me, bull markets ended amid:
- An overheating economy
- Banks that were lending furiously
- A Federal Reserve that was raising interest rates
- An inverted yield curve (where short-term rates are higher than long-term ones)
- Higher and rising core inflation
- Oh yes, and a surfeit of investor bullishness.
Seen any of those things lately? I thought not.
Instead, we have an economic recovery that, after two agonizingly slow years, looks more and more self-sustaining. Employment is finally beginning to pick up, and there’s no sign of Fed-initiated rate increases on the horizon.
Sentiment is hardly frothy, either. This week, the American Association of Individual Investors found around 38% of its members were bullish, 35% were bearish, and another 27% were neutral. In late December, an amazing 63.6% were bullish, but only 16.4% were bearish, nearly a 50-percentage-point bullish spread.
Clearly a correction was waiting to happen. And it did. But investors are still hiding.
True, the Federal Reserve is still pumping money into the system via its quantitative easing (QE2) program, but Paulsen believes the market is already discounting the end of that program in June.
S&P 1,600 Is Perfectly Possible
Most importantly, earnings growth shows no sign of slowing down. Earnings—not unemployment, not housing, not even GDP growth—power the stock market.
“US and Japanese companies are seeing the highest ratio of upgrades to downgrades [of analysts’ earnings estimates] over a three-month period out of the 24 major stock markets tracked by JPMorgan Asset Management,” the Financial Times reported this week.
This graphic shows (registration may be required) that not only are analysts increasing earnings estimates for US companies nearly twice as often as they’re cutting them, but that we appear to be early in the earnings cycle compared with the 2003-2007 bull market.
And “a record percentage of companies have beaten estimates for several quarters,” Paulsen added.
He said the S&P 500 is trading at a very reasonable 13.5 times estimates for the next 12 months—“about the same [multiple] as it was in March 2009.” His target is 1,425 by the end of the year, from around 1,300 now.
And with his estimate of peak S&P earnings of $130 a share (estimates call for $95-96 this year), plus some expansion in the multiple, Paulsen thinks we can top the record high of 1,565 “over the next couple of years.”
Lots can happen between now and then, of course, and there will be more crises and more fears—maybe even bigger ones than we’ve seen.
But unless they truly disrupt the economy and hurt corporate earnings significantly, they will remain mere hypochondria, not a fatal illness for this bull market.
Howard R. Gold is editor at large for MoneyShow.com and a columnist for MarketWatch. You can read more of his commentary and watch his videos at www.howardrgold.com and follow him on Twitter @howardrgold.
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