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What Is It?
by Mark M. Rostenko
Editor, The Sovereign Strategist
November 22, 2004

Stocks fell last week as the S&P 500 retreated from a new rally high to close sharply lower on Friday. The dollar bear continued as the Dollar Index plumbed depths not seen since late 1995 and gold rallied to yet another new bull market high. Crude oil rebounded late in the week but remains well below the $50 mark.

So what it is it? A bull or a bear? What’s going on? Seems that question is not as easy to answer as it used to be. The S&P 500 is into another upleg of the rally that began in 2002. But the Dow and the Nasdaq Composite have yet to exceed their corresponding highs. Meanwhile the small-cap Russell 2000 is at a new all-time high. A confusing and conflicted picture to be sure.

But the matter is less confusing when viewed with respect to time frame. Can I legitimately argue that a 2-year 54% advance in the S&P 500 doesn’t constitute a bull? Of course not. But can a bull argue that a countertrend reaction which retraces a little more than half of a monstrous 50% stock market decline is a clear indication that the bear is over? Of course not.

Let’s get some perspective here. The S&P 500 has bounced 54% from its bear market low. But prior to that it lost HALF of its entire value. I’m not talking in relative terms. I’m talking in absolute terms. Half of the market was wiped out between April of 2000 and October of 2002. It lost more than 780 points in 2-1/2 years. It has regained less than 420, about a quarter of its peak value. Certainly from a shorter-term perspective we’ve witnessed a bullish move. But from the perspective of a secular bear market, the move classifies as a common countertrend reaction.

I mention it to put this action into perspective, but in real terms what does it matter? I’m arguing semantics, no? If the market is going up we make money by buying it. What you want to call it, bull or bear, matters not to the bottom line.

But it does matter when we get into the issues of sustainability and investment. A traders cares little for whether the market is going up or down, only that he should be on the right side for the period in which he’s participating. But for the average market participant who is not particularly adept at timing purchases and sales, the long-term phase of the market becomes critically important.

A real bull market, a genuine, global, secular bull requires more than buying for lack of alternatives. Which is precisely where I believe the market is today. It’s gaining not on its own strength, not on the outright strength of the economy nor our future prospects, but primarily due to the lack of alternatives in a low interest rate environment in a world where the U.S. is economically unmatched. The U.S. is a VERY risky investment, but how much better are the alternatives? Not much, if at all.

But a real bull market, the kind of sustained advance we saw at the tail end of the 20^th century, requires something more. We gained from a unique blend of aggressive inflation-fighting, increasing wealth, advancing technology, new business paradigms and the “peace dividend” which freed up a lot of resources for economic growth. And we began that bull from bargain valuations, a sub-10 p/e environment, the kind from which all the great bulls have sprung. That bull market had a REAL story behind it and was driven for many years by a genuinely bullish fundamental basis.

We’re not in that environment today. There is no story. Valuations are high. The imbalances are huge, bigger than ever before in history. Savings are at an all-time low. Deficits are at all-time highs. The dollar is approaching historical lows. What is the fundamental story, the foundation upon which we’ll build a great bull market? All the great booms that pushed the market to new highs had some story, some reason why everything was going to be great from here on in and why stocks would never fall again.

There’s no story today. There are just low interest rates and a lack of alternatives.

Maybe I just don’t see the story yet? After all, doesn’t the stock market anticipate long before the story becomes apparent to chowder-brains like me? Isn’t it typical of emerging bulls that most folks doubt and only begin to buy the story when it’s getting on too late? Am I a doubter about to get swept up in the bullish storm?

I’d acknowledge that possibility were we not in this exceptionally unbalanced financial world. There are simply too many things teetering on the edge, requiring not so much to push them over the tipping point. I’m talking about HISTORICAL imbalances, bigger than ever! There’s plenty wrong and not much that’s compellingly “right."

Again, there’s no truly bullish story here. You want evidence? Mary Meeker is out regurgitating the 90s Internet story, implying that it’s all about to happen again. When you have to go back to the LAST bull market to find a story, there probably isn’t a story to find.

How profitable must U.S. corporations become in order to propel stocks to new highs without taking valuations to absurd extremes? Hedonically adjusted, I’d say “pretty freakin’ strong.” How are they to become so profitable when Americans already spend more than they earn? How likely is a massive upsurge in profitability and productivity in light of our huge economic imbalances? You tell me and we’ll both know.

There I go, sounding bearish again. Last week I caught some flak for painting a picture of an economic future that wasn’t exceedingly grim nor particularly dire. Seems that when I imply that the U.S. isn’t going to hell in a hand basket, some folks figure that means I’ve become a raging bull. But our financial world isn’t quite that black and white. It isn’t always simply bullish or simply bearish. There are varying shades of gray.

I didn’t say “everything’s OK.” I didn’t say “everything is fine.” I didn’t say “we’re in bull market”. (Although some readers insist that I did!) I said we’d muddle through. Muddling through doesn’t mean it’s a go-go bull market. It doesn’t mean that all of our imbalances will be quietly and painlessly resolved by the geniuses who created the mess in the first place. It just means I don’t quite see any need to build an underground bunker and prepare for Financial Armageddon just yet.

A couple years ago I wrote about how bear markets aren’t straight-line downward affairs. I said that “the easy part of the bear is over.” I discussed the possibility of years and years of nothing much, rallies and declines, mini-bulls and mini-bears, as opposed to consistent progressively lower lows in the stock market. That’s how “muddling through” expresses itself in the market.

We’re used to thinking in absolutes. Black or white. Bull or bear. There’s no simple term for what happens when the bear stops falling and the next bull has yet to emerge. Markets can rally and decline for years, building bottoms, before launching the next sustained secular bull. For lack of appropriate and distinguishing terminology, I lump that phase, whatever you want to call it, under the bear’s domain. I say it’s part of the bear market.

I believe we’re still there, from the long-term perspective. Still within the grasp of the bear. I don’t know if we’ll see new bear market lows anytime soon. Or ever, for that matter. But I don’t think it will get much higher because the fundamental basis required to exceed 1553 on the S&P 5000 just isn’t there. What’s going to cause the Nasdaq to double and then add on another 1000 points to exceed its bull market high?

In the meantime, there’s no telling where this rally will top out. In fact, we’re not even all that sure that it hasn’t already. The Nasdaq and Dow have both yet to confirm the S&P 500’s new rally high. Can we even be certain that the S&P 500’s breakout is legitimate in light of this glaring divergence? Not yet.

Sure, it’s gone a long way to follow through on the initial move over 1163. But how much is hype and enthusiasm resulting from late-comers afraid to miss the boat on the new bull? Only time will tell. The real test will come when the current correction ends: whether the S&P can then exceed the current rally high. In that case I’d have to be a buyer to take advantage of the trend.

But a confident buyer? No. A long-term buyer? Definitely not. A buyer and holder? Absolutely not. Try: A nervous buyer with a tight stop taking advantage of the market’s momentum as long as it lasts because it probably won’t.

© 2004 Mark M. Rostenko
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