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What the Bears Are Saying/What the Bulls Are Saying

Is the glass half full, or half empty? Maybe both. It’s not going to stay half-and-half for long though. Here are the arguments both sides are making. They’re important to define, as changes to them (or lack thereof) will confirm or abate the looming re-entry in to a full-blown bear market.

The bears are saying…..

1. All the major indices are back under the 20, 50, and 200 day lines; the 50-day averages are also under the 200-day averages…. the so-called ‘death cross’.

Stock prices are the final arbiter; if they’re under key moving averages (and they’re under all of them right now), it’s because investors haven’t thought they were worth owning in a while.

To be clear, whether they’re worth owning or not is irrelevant - a falling stock is a falling stock regardless of the reason; you simply don’t want to own it. And right now, the momentum is just perceived as bearish, so investors don’t want to touch them. (On the flipside, the ever-changing opinion on this matter has been flip-flopping a great deal of late… the reason for al the volatility.)

2. Confidence is falling again, which coincides with the beginnings of recessions and bear markets.

While one month’s worth of tumble in confidence levels isn’t a ‘trend’ that should prompt the sounding of alarm bells, all long-term trends start out as short-term trends. Therefore, the Conference Board’s consumer confidence reading as well as the Michigan Sentiment Survey should both be on everyone’s radar, as they both sank - precipitously - last month. If we see lower scores for two or three months in a row, odds are historically good that things will get bad

3. Things are so bad, rather than inflation - which we’re supposed to see materialize thanks to loads of cash - we’re seeing deflation, which is the ultimate sign of a lack of demand.

Despite tons of cash in the U.S. economic system, and despite stupidly-low interest rates, inflation has been contained to the point of being alarming. If consumers and business were even half-optimistic (or able), demand and prices for everything should be soaring. With last month’s dip in the inflation rate from 2.02% to 1.05%, deflation - a bigger problem than inflation - is a real worry. Why? It coincides with and typically exacerbates recessions.

Though deflation doesn’t technically occur until the inflation rate turns negative, the current trend is pointing us in that direction.

The bulls are saying…..

1. Unemployment is falling, even if at a snail’s pace.

Unemployment now stands at 9.5%, which isn’t leaps and bounds better than the peak of 10.2% from October of last year, but it is better. The problem on this front is more one of perception than reality - even the good numbers are tainted, with nay-sayers saying the numbers aren’t actually reflective of the true unemployment situation. Some of that argument is valid; most is not.

Either way, with new unemployment claims finally breaking their stagnation above 440K by falling to a multi-year low of 429K last week, the employment picture is still showing glimmers of hope. (At the same time, it’s worth mentioning that continuing claims haven’t trended higher since the beginning of the year. Granted, part of the reason could be the expiration of benefits for some; that’s only a small part of the reason for stability in the number though.

2. Earnings are getting better, again, even if at a snail’s pace.

Yes, Google fell short of earnings expectations, bringing home $6.45 per share rather than the estimated $6.52. However, that doesn’t mean profits shrank….. an important reality being overlooked by many. In Q2 of 209, Google earned 5.36 per share, so profits actually increased. Though that shortfall hurt GOOG shares in the short run, perhaps analysts were unfairly aggressive with their outlooks. Eventually, that earnings growth will be reflected in the stock’s price though.

A similar situation materialized for a couple of major banks. Citigroup and Bank of America both posted higher Q2 earnings results, thanks to significantly fewer loan losses. Deckling revenues, however, spooked investors out of those stocks. Not that falling revenue is something to dismiss, but which is more important - the bottom line, or the top line?

Ultimately, the market is still expected to grow net earnings from Q1-2010 to Q2-2010, and we should see earnings well above Q2-2009’s levels. The question is Q3 and beyond, but the trend now says Q3 should still be better than Q2.

3. Credit is becoming more available (and once again, even if it’s at a snail’s pace).

The lending market  hiccuped a few weeks ago. It was a short-lived hiccup though, and its rebound was already underway. Thus, the much-needed consumer was able to spend more freely again. We saw more evidence of the credit market thaw in the meantime.

Though still not back to early-2007 levels, borrowers who had not been able to get credit for quite some time are now able to again…. even in the subprime realm. Lenders are also in generally doing better keeping up with credit loans; only 5.5% were more than 30 days late as of the end of the second quarter, versus 6% from the second quarter a year ago.

So, qualified (and even unqualified) borrowers are showing interest in borrowing, while banks are showing interest in loans again. It’s still not ‘hot’, but it’s not freezing up again either.

So there you are - six specific things that will be major indications of whether or not we’re headed into a recession/bear market, or an economic growth phase/bull market.

Obviously all six are bigger-picture ideas that can’t be pinned down in a day. That’s why we’re going to keep tabs on all six (and more) over the coming weeks …so we can paint a clear picture of what’s really going on, and not get sucked into the short-term volatility that’s suckering everyone else into or out of the market (the folks who are flying by the seat of their pants, blindfolded).

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James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.