Last week started out a little on the rough side as the Dow plunged 186 points on Monday. The quick decline caused the indices to break below the bottom end of the little trading range that had developed over the past two and one-half weeks, and although the volume was very light, the bear case seemed to grow exponentially in popularity as the day wore on. And by the time the closing bell rang, the talking heads were almost unanimous in their view that a meaningful correction had begun.
The source of the discontent was three-fold. First, the chorus of negativity was growing quite loud on the back of the concept that the global recovery, which, as the glass-is-half-empty crowd was quick to point out, may or may not be happening, was almost assuredly going to be weaker than expected. Although this wasn’t exactly a new concept, you never know when a particular concept takes hold on Wall Street. So, it appeared that traders’ focus was shifting away from the end of the recession and to the strength of the recovery. Well, for a day or so, anyway.
Next up was the idea that after a gain of nearly 50% on the S&P 500 since March 9th and an eye-popping advance of 58.4% over in four-letterland, the major indices had become overvalued. It seems that everywhere you turned, you could hear about how P/E’s on the S&P were either “fully valued” or had even become overvalued enough to, in some analysts’ opinions, cause a bear market.
Then there was China. As of August 4th, the Shanghai index up something on the order of 90% since the beginning of the year (+90.65% to be exact). Therefore, it wasn’t exactly surprising to see a correction commence when Chinese officials started talking about the idea of increasing capital requirements for banks. So, with the Shanghai Composite pulling back from the highs, we heard all kinds of talks about bubbles and how the Chinese were going to make darn sure that this situation didn’t get out of hand. To which, I’d like to say, “Are you kidding me?”
Nobody Sees a Bubble Coming
While I have no real argument with the idea that the economic recovery is unlikely to be robust (however, we should note that if you’d like to take a TRUE contrarian stance, betting on a decent recovery would be the way to go) the other two arguments being offered up by the bear camp cause my blood pressure to become a bit elevated.
On the topic of trying to protect against a so-called bubble in stock prices – either here or in China – I’d like to remind our friends in fur that the majority of investors/analysts rarely, if ever, see a bubble coming. But nowadays, in light of the fact that we’ve just been through the pain of a true bubble bursting, everybody and their grandmother seems to be seeing bubbles!
Let’s take Japan in 1989 as our first example. To be fair, as the Nikkei was pushing 39,000 in December, 1989, there was some talk that things might be becoming a little overheated in the Land of the Rising Sun. However, the real talk at the time was about the Japanese way of doing business and how the jobs-for-life approach taken in Japan was a better model. At that time, we Americans were VERY concerned about getting our butts kicked on the economic front as the Japanese were busy buying up prestigious real estate such as the Pebble Beach Golf Club and too many of Manhattan’s office buildings to name. But, in the end, nobody did anything about that bubble and the Nikkei still finds itself down some 73% from the high set 20 years ago!
Then there was the Technology Bubble, which pushed the NASDAQ to 5048 in early 2000. I probably don’t need to belabor the point that the internet craze caused analysts to completely lose their investment senses. And I will NEVER forget the string of analysts coming on CNBC to tell us “traditional valuation measures no longer apply, because this is a new era.”
Yes, there was a very small number of investment pro’s such as Warren Buffett and Ned Davis who suggested that what was occurring in tech was pure folly. However, if you are fair in your thinking, you will recall that no one was concerned about a bubble developing. Heck everyone was still laughing about Alan Greenspan’s proclamation
Comments
Nunia - Well said... this is no time to putting portfolios on autopilot!
Great analysis. I do think we will have a 5 to7 % pull back before we see a push to the l200 level. If we have a better than expected GDP number in the next quater, I would bet that the l200 level will be achieved faster than most bears want. I also think that the FED's will raise rates sometimes before the end of the year, not by much, but just enought to send a signal that they are still in charge of monetary policy not wall street.