Who are the real contrarians? Bearish market analysts point to indicators related to those who are actually trading right now — AAII surveys, the option volatility (VIX), put-call ratios, and the like.
Doug Kass looks at the short ratio of hedge funds, an interesting approach. The problem with all of these measures is twofold:
- They ignore those who have left the market — individual investors who have plunged into real estate and mutual fund managers who have significant foreign market exposure–chasing recent performance. The market veterans who look at fundamentals have been "all-in" for some time, and they are not getting fresh money. This is a manifestation of the backward thinking of individual investors.
- The hedge fund measure does not reflect the vast increase in money managed by hedge funds. There is much more money in the hands of managers who short aggressively, looking for the next market tick.
The hedge fund money will shift rapidly with the market. The individuals, sadly, will come late to the party.
Here is an idea about how to see the overall risk. Let’s look at the growth in S&P earnings since 1960. Even in the very worst recessions, the earnings decline was about 15%. Take a look at the data, showing a decline of about 15% in 2000-2001, a similar amount in 1981-83, and a bit more in 1974-75.
Here is the lesson. First, there were very few declines in a 45-year history. Second they were all brief, with a brisk rebound. If you want to play for this, you had better be agile, or else think this is the worst market in fifty years.
Remember that bearish analysts are predicting a slowing in the rate of earnings growth, not an absolute decline. Remember also that they are ignoring that the analysts themselves are already projecting a weakening economy. Nevertheless, let’s assume the worst case in the 45-year market history.
Let’s assume a 15% decline in earnings from the current forward projection (Thomson First Call) of aobut 88.40. Even with that decline the forward PE of the S&P is about 16.5. This is over 6% earnings yield.
The market can ignore earnings, as it has for the last two years. It is already a very unusual phenomenon — a reverse bubble. What happens when companies get great earnings and improve their balance sheets? Let me quote from the excellent commentary by James Altucher, once again from a paid service on TheStreet.com. (If you are trading yourself, you should subcribe, or check out the views of those who do). This is a great explanation.
"S&P 500 companies are sitting with a ratio of cash over market
cap that is higher than it’s ever been before. They aren’t going to
just put that cash in a checking account while their stocks go down.
Here is what they will do:
Buy other companies; Buy back stock; Pay a dividend; Make investments in R&D and infrastructure.
those items boost stock prices and boost the economy. We haven’t even
really seen the effects yet of the massive cash that’s sitting on the
sidelines right now in corporate America."