Tidings of a bear market rally

By J Saft
October 29, 2008

James Saft — James Saft is a Reuters columnist. The opinions expressed are his own –

By James Saft
NEW YORK (Reuters) – Some time before the end of the year it is a good bet that stock markets will throw off their gloom and begin a powerful rally of as much as 15 or 20 percent.

Some time one to three months after that it is a good bet that the prospect of a deep global recession and shockingly bad earnings will send them right back down again to make new lows. Rallies in the midst of bear markets can be sustained, powerful and feel very much like the ones that often mark the beginning of a real recovery.

So, why should we believe that we could get an early, if transient, Christmas present from the stock market?

Global markets are more scared, tired and depressed than at any time in my reasonably long memory, excellent breeding conditions for a rally. Given that most people are now on the same side of the debate, it would not take terribly much by way of money being committed to developed market stocks to send them higher. There may even be some momentum investors left who will pile on if a rally can get just a little traction.

The Vix index of stock market volatility hit a record high of 89.53 last week while the ratio of bulls to bears is at a several year low. And stocks have absolutely cratered — the S&P 500 index is down more than 40 percent this year and was heading lower at the time of writing.

Secondly, in historical terms valuations are as good as they have been in quite a while and increasing numbers of stocks are appealing to even the most hard-bitten value managers.

Perhaps most compelling, bear market rallies are simply what often happens in these circumstances. Nothing, not the housing market, nor the Roman Empire nor Alan Greenspan’s reputation keeps going in a straight line in one direction.

“Whether they are bull or bear, markets move in waves,” said Albert Edwards, the famously bearish global strategist at Societe Generale in London.

“You typically get three or four rallies by 25 percent within a bear market. And even though I think the S&P is going to 500 we should get a fairly healthy bounce at some stage.”

Edwards, who has been not just bearish but structurally bearish and who in September predicted a crash, has started to put a toe back into the water, raising his weighting of equities within a diversified portfolio.

He is still underweight equities, but has moved away from more extreme levels.


And it’s not just him. Both Warren Buffett and famed value investor and long time bear and bubble detector Jeremy Grantham have recently become more positive on equities, to varying degrees and in Grantham’s case with a proviso that we will ultimately go lower.

I hate arguments of authority; a long string of them have got us where we are today. The deal must be safe, the ratings agency called it AAA. It must be sensible to borrow five times my earnings to buy a house that just tripled in value, after all the bank is willing to lend me the money. The Fed must know what it is doing.

But that said, the arguments that we may have a rally soon, even an evanescent one, are pretty good.

Grantham looked at 28 bubbles which met his criteria since 1920, all of which, including now the recent bubble in the stock market, reverted to the trend line of growth. Earlier in October, he called S&P at 900 good value and said he would be a steady buyer, though he says he is reconciled to buying too soon. He acknowledges that in the largest bubbles, 1929, 1965 and Japan’s in 1989, the market overcorrected by substantial amounts. He thinks the index, which was trading on Monday at around 880, will bottom at between 600 and 800.

Given that reverses are always part of market trends, and especially given that few awful things in life are as terrible as they seem when first the shock sets in, I do think it is reasonable to expect a rally. It could be quite powerful and will immediately get strategists and talking heads reminding us that large portions of bull market gains usually come in the first few weeks of a recovery.

But though I wouldn’t bet against such a rally, I also wouldn’t buy it a season ticket. Let’s all hope that the financial system doesn’t fall over, but let’s not confuse it remaining standing with a recovery.
Analyst expectations for earnings in the developed world are still at laughable levels. And though everyone laughs at them, stocks still get sold off when they disappoint.

The ongoing deleveraging of the Western economies has further to go and anyone with any sense will admit they don’t really know what this crisis may throw up.

So, prepare yourself for a bit of holiday season cheer, but remember that a long lean period usually come after.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –


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