Bears Call For a Rally
After its worst year in living memory, the stock market is due for a bit of relief. Whether it turns out to be a dead cat bounce or a cyclical bottom remains to be seen. But some heavyweight bears are now placing their bets on the long side. Among them:
March 4 (Bloomberg) -- Steve Leuthold, whose Grizzly Short Fund returned 74 percent last year betting against U.S. stocks, said now is the time to buy equities because investors are too fearful about the economy. "These comparisons people make with the Great Depression are totally out of touch with reality, and pretty stupid," he told Bloomberg Television in an interview today. "We've been in much worse, much more panicked and more scary situations in the U.S."
The economy isn't as bad as it was in 1974, when stocks began rebounding, said Leuthold, who oversees $3.2 billion at Leuthold Weeden Capital Management in Minneapolis. He predicted the Standard & Poor's 500 Index will surge to at least 1,000 in 2009, representing a gain of 44 percent from yesterday's 12-year low of 696.33. Because a rally is likely, Leuthold said investors shouldn't buy his Grizzly Short Fund. It has returned 26 percent in 2009.
After considerable thought and deliberation I have decided to make a major change in my life: I am going to close my hedge fund. I have several reasons for no longer wishing to run a short-only fund as I have for the past 12 years. First, my original reason for starting the fund was because of developments I saw occurring in the late 1990s that I wanted no part of. I felt that Greenspan was fomenting an environment that would lead to disaster, as consultants, financial advisors, and the public at large were losing all respect for risk. Of course, the reckless behavior carried far higher and lasted much, much longer than I ever imagined it could. However, the recent carnage in the stock market, real estate market and the financial system (as well as the job losses) has washed away those excesses to a large degree and it has violently demonstrated the risks associated with investing.
A future goal of mine, when I set up the fund in 1996 -- as I attempted to step aside from the madness -- was to return to the long side of the business at some point in time when I felt that investors had become more rational regarding risk and stocks offered a more favorable risk/reward proposition. I considered this option very briefly in 2002 after the stock bubble imploded, but the cleansing process was postponed due to the burgeoning real-estate bubble.
Second, though I think that the stock market still has unfinished business on the downside, I believe that 2009 is the year to prepare for a return to managing money in a more balanced fashion, with longs (and some shorts), as there are currently plenty of interesting ideas that appear to offer a margin of safety. On the flipside, compelling opportunities on the short side are not as abundant as they were just a few months ago (though there still are plenty.) The "value restoration project," to quote Jim Grant, has been brought about by the consequences of disastrous Fed policies and the madness of the crowd, both of which have concerned me for the last 15 or so years.
Feb. 24 (Bloomberg) -- Elliott Wave International Inc.'s Robert Prechter, who advised shorting U.S. stocks three months before the bear market began, said investors should end that bet after the Standard & Poor's 500 Index tumbled to a 12-year low. He warned of a "sharp and scary" rebound for anyone still wagering on a retreat, according to this month's "Elliott Wave Theorist." Short selling is the sale of borrowed stock in the hope of profiting by buying the securities later at a lower price and returning them to the shareholder.
"This is an environment of escalating financial chaos," wrote Prechter, famous for cautioning that stocks would crash two weeks before the Black Monday retreat in 1987. "Our main job is to keep the money we have. If we exit now, we will do that."
The S&P 500 has sunk 52 percent since its October 2007 record as financial firms worldwide posted $1.11 trillion in credit-related losses and the U.S., Europe and Japan fell into the first simultaneous recessions since World War II. In July 2007, Prechter advised shorting U.S. stocks, saying "aggressive speculators should return to a fully leveraged short position."
Could we see a buying opportunity?
It is a characteristic of bull markets that sell-offs are short, sharp, violent and bigger-than-expected - so much so that people question whether the bull market is still intact. The same applies to bear markets, only in reverse. You get these sudden, short-covering spikes up as traders who've been betting on falls rush to cover their positions. These spikes - if timed well - can be good money-making opportunities for those who have the spare cash to dabble in short-term trades.
I think we could be reaching one such opportunity - and it could come as soon as Thursday. Here's why...
Here is a long-term, log chart of the S&P. As you can see by the red trend lines, there is a clear, long-term channel in place. We have come back to the lower line of the channel. That is, technically, a likely place to find a bottom.
As trader Michael Hampton of Global Edge Investors observes, what is interesting is that we have also retraced to the levels of late 1996 when the S&P broke out above that long-term channel. The markets have come back to 'revisit the scene of the crime'.
What crime though? What happened in late 1996? Well, it's worth noting that this break-out came just a month before Alan Greenspan's famous 'irrational exuberance' speech of December 5th, 1996, when he said: "How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy."
Despite the warning in that speech, Greenspan did nothing to rein in credit growth - the credit growth which resulted in the greatest debt bubble of all time, the consequences of which we are all now suffering. And in fact, that break-out above the long-term trend-line marked the beginning of the era when the banks began to outperform the general markets - the era of cheap credit - an era which ended on February 26th 2007, when the banks began to underperform. It was the era of monetary irresponsibility. The stock markets have now lost all the gains that were made.
So that's one reason to expect a bounce - we are at a nice technical level at which to find a low.
Why else should it come now? Well, bearish sentiment is now overwhelming and everywhere. It has flooded the mainstream. One example came yesterday when Max Hastings wrote in the Daily Mail: "The stability and political fabric of entire societies are imperiled by the meltdown of capitalism's institutions". Sentiment doesn't get much more bearish than that.