The Bear Market is Only Beginning
Long before it became headline news, we were talking about the corrosive effect of excessive debt, the softening U.S. and global economy, the “fiscal cliff”, the implausibility of a European solution, the probability of a hard landing in China and the prospect that corporate earnings estimates were far too high. Now these negative stories are carried in the Wall Street Journal every day. This week alone carried articles on downward earnings revisions at major corporations, Brazil’s sputtering growth, the worsening slowdown in China, new austerity measures in Spain and Italy, the continuing disappointment in U.S. economic indicators and more worries about the fiscal cliff. As if that were not enough, the news has been full of reports on the fixing of Libor rates, the fraud at Peregrine Financial and the J.P. Morgan losses.
In the face of the now-obvious negative outlook, the question we get most often is why the market has declined so little and why it seems so resistant to bad news. In our view the reluctance of the market to give up much ground is typical of many past market declines and reflects a state of denial by investors as they grasp at reasons to remain bullish. Currently, the reasons cited most often are that the market is cheap, corporate earnings are strong and the Fed as well as other central banks will provide all the liquidity that’s needed to avert a serious economic downturn. We believe that each of those evaluations is flawed.
The current earnings estimates for 2012 are unlikely to hold up and the market is not undervalued. The consensus estimate for S&P 500 operating earnings is about $104 for 2012 and $118 for 2013. The bulls simply multiply the 2012 estimate by 15 and come up with a prospective S&P of 1560 (usually something between 1500 and 1600). Various studies, however, indicate that the more relevant method is use a trendline estimate of reported (GAAP) trailing earnings. Our estimate of trendline earnings is currently about $75, and, on this basis, the market is overvalued rather than undervalued. The problem is that estimates of forward operating earnings are almost always wrong by a wide margin, most often on the high side. In May 2008, for instance, the estimate for 2009 was $110, and eventually came in at $57. In this regard, it is noteworthy that although the second quarter earnings report season has barely started, 42 major corporations have already guided their estimates down. (For more detail on this topic, please see our comment of April 5, 2012, in our archives).
In a similar vein, we believe that investors’ faith in the ability of central banks, including the Fed, to avert a serious downturn is ill advised. In 1999 and early 2000 we had the so-called “Greenspan put”, which referred to the supposed ability of the Fed to avert a recession. Despite the fact that it didn’t work, investors still had great faith in the so-called “Bernanke put” in 2007, and we now know how that worked out. Despite the disastrous outcome in those instances, investors now seem to have great confidence in a global central bank put. In our view global debt deleveraging will overwhelm any central bank attempts to prevent a serious downturn, particularly when we take into account that central banks have already used their best ammunition and have to rely on unconventional and untried measures with questionable chances of success.
In the last four major bear markets the decline started very slowly from the peak, and was interrupted by numerous rallies, but continued to gather steam, ending only after a scary waterfall decline toward the end. We suspect that the same pattern may happen this time around.
4 Comments
I am old enough to remember their accurate analysis and forecast before the 1987 crash. I recall there was a Barrons cover article featuring the above.
Oh yes!
Folks will quit using oil, food, utilities, quit everything! According to Comstock they will all quit breathing.
Come on! Who writes this gibberish? The sun will come up, folks will go on with their lives and babies will continue to be born.
Of course there will be problems as long as people are in charge of it all. Politicians will always do the wrong thing when push comes to shove. But ultimately smart people will prevail. People and companies will continue to make money, better and more products and new ideas will come to market.
Does anyone really think they can time the market? Then you need to write and sell crap like this article as that is where the only profit is in market timing.
I have been regularly buying good stocks and holding them for years and watching their yield (based on my initial investment) grow steadily fatter. Market timing? Its great for the brokers. Look at who the sponsors are on this site! ’nuff said.
Ditto!
Agreed that market timing is impossible. But I think Comstock is pretty spot on here. The rallies may continue, Europe may plug along for a lot longer than people think, China may print a stimulus equal to 20% of GDP this time, but sooner or later mother nature is going to clamp down on the market. When is the big question. Maybe a more defensive mix with nice yields, clean balance sheets, and deep value is the best portfolio here. Still not buying home builders, banks etc.