let's revisit the bullish case

[grapejelly]

1. sovereign wealth funds investing in equities -- bullish for equities

2. the central banks inflating like crazy. Who's gonna stop 'em? How can equities and commodities fall for very long if this continues?

3. the US housing bust is soooooooo sloooooooooow. And it is based on middle and lower income houses, more than high end houses. The people who don't have the money are falling further behind, while the people with the money are doing just fine and, may I ask, why can't they continue doing so? And since they have the money, might not this prevent a genuine banking crisis/crash?

4. Booms go on a *lot* longer than anyone can dream.

Scenario: there is a 10% - 15% correction in equities this year, followed by relentless increases in equity prices. This continues into 2008. Meanwhile, bond yields rise but somehow, with massive central bank intervention, stocks don't fall. By 2009, it becomes common knowledge that inflation isn't under control. This continues to 2011 or so when fiat currencies finally crash and there is a crack up.

Is this any less or more plausible than any other scenario?

Might the bull case have a lot more legs to it than we believe?

[Tet]

Might the bull case have a lot more legs to it than we believe?
What's the historical case for boom and bust?
Panic of 1848, Panic of 1873, Panic of 1890, Panic of 1907 and Panic of 1929. Note all of these Panics are about twenty years apart. I don't know about you but I certainly had a Panic in 2001. From a timeline the Bullish case should be noted and we should have another 15-years before the next Panic. Still a lot more bagholders more afraid of a 2001 market drop as opposed to believing in another 2000 market rise. Market needs to get higher in order for Wall Street and the hypsters to steal every last cent, everyone needs to be long for there to be a good crash or Panic.

[jk]

i, too, have been reconsidering the bullish case, and for much the same reasons gj. ray dalio, interviewed in barron's a couple of weeks ago, said there were three important processes going on: "there is an economic market cycle, there is china and the oil factor, and there is leverage." he says that the deflationary effect of the sharply increased global labor pool is that capital and commodities get pushed up. if you think of the global central banks as targeting some positive inflation rate, then given a deflationary hit coming from chindia et al, money will be pumped and go to the other production factors. so we have, according to dalio, 100% of the world's countries showing economic growth. [i think he's wrong about zimbabwe, lebanon and i suspect iraq, but the nature of these exceptions highlights how generally true his observation is - jk.]

i also agree that the national investment funds being put together will channel dollars from the tbond market toward, directly or indirectly, equities. so where are the risks?

i see 2: a financial accident, and a recession.

it would take a substantial financial accident to upset the apple cart. $6billion amaranth didn't cause a blink or a hiccup. but we don't know what risks may be buried in the layers and layers of interlocking derivatives and counterparty obligation. on the one hand, we have the fact that cdo's are seemingly widely disseminated in pension fund portfolios and the like. if so, this will cause some portfolio losses but no insitutional collapses. on the other hand, we have phenomena like the piece i posted called "paper chase," in which attempts at foreclosures are being thrown out of court because no one can figure out who really owns the obligations. this is humorous at a small scale, but if there is ever a significant market dislocation and institutions are trying to collect on their cds's, they better be able to figure out who their counterparties are, and they better be able to make it stick in court, and those counterparties had better be solvent. otherwise we risk a freezing up of the financial system.

in case 2, a recession, we have 2 subcases- a mild recession in just the u.s., or a deep recession which likely drags the rest of the world along.

in the first case we could see current trends exacerbated a bit, a bit quicker decline in the dollar, a relative rise in prices for goods and commodities, and a further readjustment among classes of equities. i put it that way because i'm very aware of u.s. capital flight - the large equity flows have been going into foreign equities. the recent leadership of the dow industrials in particular, and big caps more generally is likely rooted in the fact that these companies are multinational, and benefiting from the translation of their foreign currency revenues. the theory here is that any u.s. recession is shallow, or perhaps avoided altogether. it is notable that the u.s. is now the slowest growing economic region [if you allow me to lump japan in with the rest of asia], so it is no longer the case that the world needs a u.s. "locomotive." the more slowly the housing bust and u.s. consumer retrenchment plays out, the more easily the rest of the world can withdraw from its dependence on exports to the u.s.

in the case of a deep u.s. recession we face a sharp drop in the dollar, a sharp decline in other countries' exports, and the likelihood of global recession, followed by global attempts at reflation. this is not a bullish scenario, but it doesn't appear very likely at the moment.

writing this i am acutely aware of the parallels that exist between our current circumstances and those which existed in the summer of 1987. [tet, somehow you left that panic out. let's see, 20 years from 1987 brings us to....] rising rates, weakening dollar, rising equities. the '87 event was exacerbated by portfolio insurance. unfortunately i think we have a lot of similar portfolio insurance today with cds's and dynamic hedging. so i don't think risk can be ignored. but as scary as '87 was, the economy wasn't hurt. i'm not sure the economy, given its leverage, could sustain such an event today.

on a broader scale, this is all part of the process of world economy leaving "the american century" for a very different time. but such processes take a lot of time. with luck we'll avoid big wars or big depressions.

[Tet]

writing this i am acutely aware of the parallels that exist between our current circumstances and those which existed in the summer of 1987. [tet, somehow you left that panic out. let's see, 20 years from 1987 brings us to....] rising rates, weakening dollar, rising equities. the '87 event was exacerbated by portfolio insurance. unfortunately i think we have a lot of similar portfolio insurance today with cds's and dynamic hedging. so i don't think risk can be ignored. but as scary as '87 was, the economy wasn't hurt. i'm not sure the economy, given its leverage, could sustain such an event today.

hey come on this was a Bullish Case Article. :)

on a broader scale, this is all part of the process of world economy leaving "the american century" for a very different time. but such processes take a lot of time. with luck we'll avoid big wars or big depressions.

My Bearish Case would be, US pulls out of Iraq or Afghanistan before other Federal Spending/Borrowing is arranged ie Bolshevik Medicine. US Third Party candidates or fringe Federal Party candidates doing well in the election, especially Ron Paul. US gives up on Polish Missile Shield, Russia no longer distracted. If any of the above happens market heads to zero in 9 trading days.

[jk]

just wanted to add that i think ej is coming to this view. at least that's how i interpret his last piece in which he discussed the possibility of pumping up another bubble versus the slow hiss of air coming out of the housing bubble. what is that but a "bullish" scenario? i put in those quotes, however, to indicate that one can see such a scenario and still have concerns about its foundations. still, if such occurs over the course of a few years, that's a long time to await armageddon.

[rachits]

I've been lurking on this site a lot, and this thread piqued my attention.

I've been fairly negative on the outlook on the global economy and the stockmarket in general in the past two years (and have recently started to bet against it).

Of course, i've been losing money. The funny thing is I've started to think along the same lines of this thread and thinking of closing my short positions. Maybe the bust is going to happen in a couple years, just not right now.

Lets just say that the last times i've had these thoughts were early 2000, Feb this year and right now...

[grapejelly]

Lets just say that the last times i've had these thoughts were early 2000, Feb this year and right now...

See, that's how I feel too. I feel like when I am ready to capitulate and become bullish, The End Is Near :)

[c1ue]

Keep the faith people!

One good thing about travelling around is that you have the opportunity to gauge 'man on the street' foreign sentiment about the US.

10 years ago - everyone wanted to come to the US for the greater opportunity.

Today, everyone wants to make tons of money where they're at.

Given that the American economy is so dependent on foreign loans - can the foreign ECBs continue their mercantilist practices given the increasing domestic demand for investment?

[bart]

...
3. the US housing bust is soooooooo sloooooooooow.
...


Just for perspective - I believe we're in step 7 and transitioning to step 8.



The Stages of the Real Estate Cycle

1. Population growth and commercial growth at the early stage of the economic cycle, often supported by government encouragement/ low interest rates, creates an increase in the demand for housing and commercial buildings in excess of current supply.
2. It takes time for construction to gear up. This construction increases demand for vacant land. Bank loans are attracted to construction and real estate sales as prices begin to rise.
3. As vacant land prices rise a boom in land develops, leading to sub-divisions and speculative resale.
4. The real estate cycle peak is characterized by a high volume of subdivision and sales.
5. Construction catches up with demand and a small surplus is created. Rents can't go up enough to support the higher property costs, making new construction and rental property investment unprofitable. Land values start to adjust downwards, the bubble/mania is broken.
6. Rising interest rates hurt confidence and profits, adding to the downwards pressure on prices. Real estate enters a 'hanging' slow phase. Asking prices stay high but there are few buyers. Building, subdivisions, and speculation drops quickly. Sometimes a panic or crash begins at this point; often the market just slowly dies. Many keep speculating during this phase as they're unaware of the market having turned.
7. Real estate starts to get marked down in price. This tends to take quite a while as owners tend to cling to mortgaged property longer than they would to other assets, like shares. Foreclosures rise but the foreclosure process is not quick.
8. Mortgage costs/interest rates are higher, rents decline, and vacancies increase. The market is dying rapidly. Foreclosures increase; speculators and investors are forced to sell as the capital value of their property decreases below lending margins and rents decrease below holding costs.
9. The bottom of the market has the following characteristics: high vacancies, low construction rates, foreclosures and no speculation. Debt must be written off and properties sell at a deep discount. Only those who entered stage 6 with little or no debt survive to buy the dramatically discounted properties.

* Note that in a typical real estate cycle that non-residential (commercial & industrial) real estate follows residential trends with a time lag of about 5 quarters.

[jk]

Just for perspective - I believe we're in step 7 and transitioning to step 8.



The Stages of the Real Estate Cycle

1. Population growth and commercial growth at the early stage of the economic cycle, often supported by government encouragement/ low interest rates, creates an increase in the demand for housing and commercial buildings in excess of current supply.
2. It takes time for construction to gear up. This construction increases demand for vacant land. Bank loans are attracted to construction and real estate sales as prices begin to rise.
3. As vacant land prices rise a boom in land develops, leading to sub-divisions and speculative resale.
4. The real estate cycle peak is characterized by a high volume of subdivision and sales.
5. Construction catches up with demand and a small surplus is created. Rents can't go up enough to support the higher property costs, making new construction and rental property investment unprofitable. Land values start to adjust downwards, the bubble/mania is broken.
6. Rising interest rates hurt confidence and profits, adding to the downwards pressure on prices. Real estate enters a 'hanging' slow phase. Asking prices stay high but there are few buyers. Building, subdivisions, and speculation drops quickly. Sometimes a panic or crash begins at this point; often the market just slowly dies. Many keep speculating during this phase as they're unaware of the market having turned.
7. Real estate starts to get marked down in price. This tends to take quite a while as owners tend to cling to mortgaged property longer than they would to other assets, like shares. Foreclosures rise but the foreclosure process is not quick.
8. Mortgage costs/interest rates are higher, rents decline, and vacancies increase. The market is dying rapidly. Foreclosures increase; speculators and investors are forced to sell as the capital value of their property decreases below lending margins and rents decrease below holding costs.
9. The bottom of the market has the following characteristics: high vacancies, low construction rates, foreclosures and no speculation. Debt must be written off and properties sell at a deep discount. Only those who entered stage 6 with little or no debt survive to buy the dramatically discounted properties.

* Note that in a typical real estate cycle that non-residential (commercial & industrial) real estate follows residential trends with a time lag of about 5 quarters.
the question,though, is how much the housing problems will hobble the rest of the economy, and whether the growing economies of every other country in the world can keep growing [and have their markets continue to rise.]

[bart]

the question,though, is how much the housing problems will hobble the rest of the economy, and whether the growing economies of every other country in the world can keep growing [and have their markets continue to rise.]


Ah yes grasshopper... and thar be the rub.
How much can expectations be managed applies too, and that is very much the current game of the Fed and main stream media.


There is a certain point where "market psychology" takes over and nothing the Fed or any CB can do will reverse it, at least on the short term. We haven't hit that point yet... and even at the depths of the last recession there were many stats going up and more than a few thinking that all was well... and even nominal GDP never went negative on an annual rate of change basis.
In other words, most of the economies will continue to show growth but many will actually be shrinking.

Housing has already had a large effect on the economy and it will get larger, especially when a bearish attitude gains momentum and the MSM start to wring their hands. When Time magazine has a cover on how awful real estate is, that'll be the bottom.

[Jim Nickerson]

To me the most bearish thing now is that iTuliper's are even discussing the "bullish case."

Additionally, interest rates keep going up. I take that as having bearish implications.

Yesterday as we went through it, the volumes, as I follow them, were very unimpressive, and we had a bit of reversal in the equity indices at the time I bought some short positions from the indices having been up on poor volume to being down.

I guess considering these three factors more than any other, I went short the Proshares DXD, SDS, QID, MZZ, and TWM. Not a lot, mind you, only about 2.8% of portfolio.

Am I sure I did the right thing? Absolutely not. And I considered selling my small gold and silver positions, but didn't; however, I haven't dismissed that I may yet sell them.

[TraderJoe]

I guess considering these three factors more than any other, I went short the Proshares DXD, SDS, QID, MZZ, and TWM. Not a lot, mind you, only about 2.8% of portfolio.

Jim, if you are shorting these particular ETFs (ultrashort), aren't you then "long" the market?

[Jim Nickerson]

Jim, if you are shorting these particular ETFs (ultrashort), aren't you then "long" the market?


Poor use of the English language on my part. I am long the shares that move inversely to the indices. Thanks for pointing out my lack of clarity.

There was another such opportunity today, but I was fooling around and missed it. Market up on less than average volume and then reversed.

Personally, I cannot believe the hit bonds are taking.

[Tet]

Personally, I cannot believe the hit bonds are taking.

Unbelievable and I was unbelievablly lucky I had bond funds in an IRA that I had just rolled over into my 401K, two and a half weeks ago. No way I would have seen that coming and no way I would have gotten out of the way of that truck before it hit me. Sometimes its better to be lucky.


http://quotes.ino.com/chart/history.gif?s=CBOT_US.M07&t=l&w=15&a=50&v=dmax


I would definitely call 102 a buy, quite the plunge so far.

[TraderJoe]

Market up on less than average volume and then reversed.


Do you use a service to make volume determinations as to weak volume/strong volume relative to time of day? OR is it a "feel"/"eyeball" guesstimate on your part?

Thanks,

[Jim Nickerson]

Do you use a service to make volume determinations as to weak volume/strong volume relative to time of day? OR is it a "feel"/"eyeball" guesstimate on your part?

Thanks,

Using online.wsj.com (subscription), I download the Adv/Dec issues and volumes for NYSE and Nasdaq every 15 minutes on the quarter hours and in a spread sheet compare that volume to a database of average quarter hour volumes. I made my database from end-of-day data from same source which also breaks down the data to quarter hour periods for the NYSE. I have used those NYSE numbers to "fudge" similar numbers for quarter hour volumes for the Nasdaq data.

So it isn't exactly guessing, but neither is it really accurate, but it is way better than nothing.

Interesting for the moment, 11AM EDT, the NYSE volume thus far is below average by ~38M shares, and the NASDAQ is about 68M shares above average for 11AM. So certainly no frenzy in volume is being demonstrated even though the indices are up.

[fogger]

My Bearish Case would be, US pulls out of Iraq or Afghanistan before other Federal Spending/Borrowing is arranged ie Bolshevik Medicine. US Third Party candidates or fringe Federal Party candidates doing well in the election, especially Ron Paul. US gives up on Polish Missile Shield, Russia no longer distracted. If any of the above happens market heads to zero in 9 trading days.

Agreed. Ron Paul will quickly end the charade and bring instant pain, but his policies will likely pull us out more quickly and stronger for it. Of course, he will be blamed for the short-term pain which plays directly into globalists hands. So Ron Paul winning in 2008 is not without risk, but the rewards are great.

Alternatively, we accept the status quo and wait for the charade to end on its own. Then we rely on Hillary's policies to pull us out. FDR II.

[Tet]

Agreed. Ron Paul will quickly end the charade and bring instant pain, but his policies will likely pull us out more quickly and stronger for it. Of course, he will be blamed for the short-term pain which plays directly into globalists hands. So Ron Paul winning in 2008 is not without risk, but the rewards are great.

Alternatively, we accept the status quo and wait for the charade to end on its own. Then we rely on Hillary's policies to pull us out. FDR II.

Yep, FDR II or Lincoln II I really can't tell the difference anymore. Funny that we have Mr. Moore's Sicko on the front page this morning, who better pushing for Bolshevik medicine than Michael Moore, so no matter who wins in 2008 we know where the Federal borrowing is going to go and who's pockets are going to be lined. Place your bets in the casino accordingly.

[JayDee]

The bull case rests on relatively undemanding P/E ratios and scarce competition from other asset classes, given that real estate is overvalued and bond yields are unattractive. The skeptical answer to the bull case is that profit margins are unsustainably high and due for a big dose of mean regression.

Consider TXU, a regulated utility with an astonishing 34% pre-tax margin. Or Allstate with a 20% pre-tax margin. These kind of windfall margins in regulated industries can't possibly continue, unless regulators are a lot more corrupt than I give them credit for. Commodity producers also seem destined for some mean regression, even if it's a rising mean to which they regress.

I think the way to finess the bull vs. bear debate is to do as the smart empiricists like Buffett and Grantham are doing: buy the quality U.S. big caps that haven't participated much in the 2003-2007 bull run like JNJ, WMT, GE, PG, etc. They are priced for an unsexy 8-12% return, which looks very good indeed on a CAPM, risk-adjusted basis.

[Finster]

1. sovereign wealth funds investing in equities -- bullish for equities

2. the central banks inflating like crazy. Who's gonna stop 'em? How can equities and commodities fall for very long if this continues?

3. the US housing bust is soooooooo sloooooooooow. And it is based on middle and lower income houses, more than high end houses. The people who don't have the money are falling further behind, while the people with the money are doing just fine and, may I ask, why can't they continue doing so? And since they have the money, might not this prevent a genuine banking crisis/crash?

4. Booms go on a *lot* longer than anyone can dream.

Scenario: there is a 10% - 15% correction in equities this year, followed by relentless increases in equity prices. This continues into 2008. Meanwhile, bond yields rise but somehow, with massive central bank intervention, stocks don't fall. By 2009, it becomes common knowledge that inflation isn't under control. This continues to 2011 or so when fiat currencies finally crash and there is a crack up.

Is this any less or more plausible than any other scenario?

Might the bull case have a lot more legs to it than we believe?

Some might say it's picking nits, but it doesn't sound to me like a bullish case at all. Not that you haven't made a good argument, but the conclusion is not that stocks will rise, but rather that they will outperform the USD (and most UST). The popular stock averages are nothing more than stocks:dollar ratios, and all of them are a stock:some (usually depreciating) currency ratio. If the Dow Jones Industrials rise to 18,000, but you can buy less with it than you could at 12,000, I wouldn't say they went up. I'd simply say they went down less than the dollar!

It may be more to the point to ask whether stocks will outperform anything else you could invest in. That's a tougher Q to A. Over the next twenty years, I'd say probably stocks will be the best performing major asset class. Over the next five, however, when we talk about making a "bullish case", we won't just assume it's equities we're talking about ...

For some perspective, here is a chart showing the real price performance of stocks since about 1870. Over the long term, they've gone nowhere in real value; all of their real returns have come from dividends. Below that is a chart showing real total return performance on the same scale over the same time frame for comparison.

Message: An overall rise in stock prices is not returns, it's inflation. In the long run, investing in stocks gives you an inflation hedge and a real return in the form of a yield. In fact, it was only in the late 1950s that stock yields generally fell below bond yields for the first time - never to look back - as investors belatedly realized inflation was going to be a permanent fixture of the financial landscape. We have since become conditioned to expect our returns to come in the form of rising prices - but permanently rising stock prices are possible only through permanent depreciation of the currency.

http://users.zoominternet.net/~fwuthering/Posts/RealStockPrice

http://users.zoominternet.net/~fwuthering/Posts/RealStockReturn