The return of the bull market?(Read article summary)
As long as the economy keeps growing on a foundation based on debt, the bull market cannot last.
Did you miss us, Dear Reader?
You wonât believe thisâŚwe hardly believe it ourselvesâŚbut after months of planning and preparation for our expedition to the high, dry mountains of Argentina, weâre still here in the city of SaltaâŚ Our project has been delayedâŚby floods.
As you may recall, it is so dry up at the ranch that visitors wonder what the cows eat. We tell them we have developed a new race of low-fat, low cholesterol cattle we call âsand fed beef.â
But what ho! Now we are still in Salta, a city about a 5-hour drive from the ranch, and we are stuck.
âWellâŚâ says our foreman ââŚthe road to Angastaco is blocked by the river. The road to Molinos is blocked by mud. But you donât have to worry about that. You canât get anywhere near there, because the road to Cafayate is impassable because of rockslidesâŚand the road over the mountain pass has been washed out completely.â
Yes, dear reader, we have been hit by a low, unexpected blowâŚfrom water! The ranch got only 120 mm, or about 5 inches, of rain last year. The year before it was only about 4 inches. It looked to us as though the whole place was going to dry up and blow away.
But so far this year, the gods have poured 15 inches of water on that parched groundâŚand it keeps raining. Fifteen inches is not a lot. Not for Maryland. But up in the barren mountains, the water rolls of the rocksâŚdown through the gulliesâŚand fills the rivers. Soon, it is over its banks, floating automobiles and rolling boulders.
âTheyâre clearing the main road now,â says our friend. It should be passable tomorrowâŚif it doesnât rain tonight. But getting from Cafayate up to your ranch is another matter. Nobody knows what has happened up there. Theyâve been cut off for weeks.â
And so, we cool our heelsâŚwe rest our headsâŚwe pace the room and watch the skiesâŚeager to see a ray of sunlightâŚand some hope of proceeding to our objective.
And soâŚwe have time to reckon after all.
And we reckon that investors are in âhope mode.â How else to explain the recent bullishness? Albert Edwards elaborates:
One key lesson from Japan is that an essential ingredient to the end of a long valuation bear market is revulsion. It is when âbuyers-on-dipsâ become âsellers-on-ralliesâ. It is when volume dries up to almost nothing. It is the loss of hope. In Japan we saw huge rallies in the Nikkei on the back of short-lived cyclical recoveries. Each cyclical failure and further new lows in the equity market saw hope being progressively crushed. Previous US valuation bear markets typically take 4 or 5 recessions to fully play out. We have only had two.
The market is once again in a hope phase â hoping that the US is now in a self-sustaining recovery; hoping that China might be soft-landing; hoping that the Greece bailout and the ECB liquidity polices have settled things down in the eurozone. These bursts of hope are essential in long bear markets. Essential in the sense that hope must be crushed. It will be crushed. Hope still beats in the breasts of equity investors. The market will rip out that hope and consume it in front of investorsâ eyes. Only then can the bull market begin.
In our view, the real turning point came in the year 2000. Thatâs when Americaâs decline began to speed up. Itâs when the credit-driven economy could no longer produce real jobsâŚor real GDPâŚor real wealth.
Stocks rose. But they were rising on a bubble of debt. Then, it was mostly private debt. Now, they rise againâŚthis time on public debt.
Either way, it canât last. Eventually, the bear market will resumeâŚtaking down the prices of assets until they are cheap again. At 16 times earnings, stocks are higher than usualâŚand earnings are at near record levels. We expect earnings to fallâŚand stocks to fall tooâŚ Then, they will keep fallingâŚuntil they finally reach the bottom. Edwards:
A flattening of the profits cycle is exactly what you might expect as the easy, early cycle productivity gains come to an end. It is worth noting that the last time this occurred was just ahead of the start of the recession which the NBER date as having started in December 2007. Back then too, both markets and policymakers all felt the economy was still quite healthy. Indeed neither non-farm payrolls nor the headline ISM signaled the economy had already entered recession at the end of 2007 â indeed like now, payrolls actually accelerated in the second half of 2007, just as profits began to slip!
But we canât reach the bottom of this cycle unless and until investors give up hope. As long as they have hope they will buy the dips, hoping to catch the next up-move. Only when they become convinced that there will be no move to the upside, will they stop buying the dips and prices can finally fall to their ultimate low.
Hope must be destroyed. Then, a real bull market can begin.
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