Macro strategist Barry Ritholtz has been at the center of some interesting conversations this week (or maybe it just seems that way since I love his blog). However, the debate over the future of the rally may be the most important.
A couple weeks ago, the guru du jour Doug Kass penned a piece “Market Has Likely Topped” while the S&P 500 was circa 1040. As with Nouriel Roubini, I do not know Doug (although I hear he is a great guy). But without looking at the author’s name, Doug’s article makes mostly the standard bear case which has been circulating trading desks for as long as I can remember. Unfortunately, most of the smartest people I know have been bears, and their voices are starting to exhibit a low-grade shrill as their portfolios and warnings go completely unheeded by the sheeple under the spell of Bernanke’s ubiquitous positivity.
Interestingly, the bears have forgotten how rallies work: more people buy the dips than sell the rips. During the current rally (since March), at each critical juncture during a pullback in the markets, bulls have pounced on issues offered at a discount from the nearest short-term peak. This, my friends, is called a “trend.” And, no matter how many people tell scary stories with their megaphones, the trend will not end until it does. Did bears not learn the lesson of ’99-2000? Let me refresh: the market can stay irrational longer than you can stay solvent.
I am not a psychic, nor do I pretend to be one (although pretending appears to be mighty lucrative). However, in early August I asked a simple contrarian question based on the amount of kindling and performance chasing that existed to feed the rally: “Is a Mini Bubble Brewing?” Although economic reality may not be drastically improving, I get a strong sense the average person wants desperately to believe it is. I get the same sense about money managers who don’t want to look like asses if they remain under-invested during what has been one of the largest snap-back rallies in history. It’s one thing for TV celebs such as Nouriel Roubini to disingenuously take credit for nailing the crisis. It’s an entirely other situation to have that celeb status get questioned by some guy who works at Walmart because guys like Roubini said to stay on the sidelines while the S&P 500 exploded over 55% in two quarters.
So, the debate rages on. In addition to the fuel for the rally I mentioned in “Is a Mini Bubble Brewing?“, Barry Ritholtz has a nice set of evidence I’d like to add to my collection:
Here are the 4 most reasons why I think we can have more upside, plus a look at some grim economic realty.
1) Individual investors remain under-invested (See Liquidity/Sentiment Review).
2) Market Breadth and momentum are each positive (i.e., supportive of further upside)
3) The broader investment community believes — incorrectly in my opinion — that a recovery is upon us, profits are getting better.
4) History shows that secular bear markets have deep selloffs and huge rallies; this current rally still has room to run based upon a composite of prior cycles (See Four Stages of Secular Bear Markets).
Now, about that economy. Here is my dirty little secret. FOR TWO THIRDS OF THE TIME, THE ECONOMY REALLY DOES NOT MATTER.
There are a lot of people who are hardly participating in this historic rally. I don’t know how this thing will end, but if we keep lifting higher and those people start feeling the existential fear that they’re missing out on winning back their gaping losses, you better believe this market can go parabolic for a classic blow-off top. So, the lesson is simple: don’t get short until the market rolls over. If you get short any sooner than that, you have lost your discipline and are not playing the probabilities. Rather, you are putting coins into the slot of a broken crystal ball.
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