The Triumph of Bearish Pundits

Paul Kedrosky's Infectious Greed has long been one of our favorite daily reads and a recommended site on our blogroll.  In a recent column, Paul wonders "Why Bears Always Have the Best Arguments."  He introduces the idea with the following statement:

Even though the stock market has rightly been called the triumph of the optimists, with bulls stomping bears over and over for one hundred years, stock market bears not only haven't gone away, but they generally have the most compelling arguments. Their points seem so damn plausible, level-headed, empirical, and reasonable, while bulls come across as starry-eyed idealists.

Not only is the question interesting, Paul has some good ideas for answers and stimulated some excellent comments.  Take a look at the entire post and comments, and then our take.

Importance for Investors

This is a very important question for individual investors.  Since these investors constitute our primary client base, we are on the front line of what they are thinking.  Many of them have been afraid of stocks every since the 2000-01 era.  Not only have they missed out on big market gains, many have also over-committed to real estate at exactly the wrong time.  Why is this?

How the Most Intelligent Investors React to News

On most subjects, intelligent people are informed by reading about what is happening.  At cocktail parties they can discuss the upcoming election, free trade, the Iraq situation, and other current events.  When it comes to stocks, they believe that the same criteria for knowledge works just as well.  When the average intelligent investor comments to me about a stock, I often ask whether they believe that this information might be reflected in the current price.

Amazingly, the question seems to baffle them.  The idea that what they read in the New York Times, or the Wall Street Journal, or on popular blogs might have already had an important effect on markets seems like a novel approach.

Briefly put, most investors lack the ability to determine what is already reflected in the market.  They treat what they read as "inside information" that confers some special advantage.  As a result, most fail to recognize the possible advantage of buying in times of extreme worry.

Our Own Answer

A major thesis at "A Dash" can be summarized as follows:

Problems are known; solutions are not.

Paul suggests as one of his own answers, "Bears have the past, and bulls have the future. Bears get to argue from data, while bulls argue from what might happen."

Commenter "Doug" wisely writes as follows:

People are pretty good at responding to a problem. Most bearish arguments assume that people cannot adjust, problems cannot be addressed,and things will go on pretty much as they have. Many problems get solved. Go back and read a newspaper from 40 years ago, it is filled with problems that simply never amounted to very much. Most of the bearish problems will end up in the same scrap heap. Good long term investing means figuring out the real issues.

Doug does not provide any identifying information, but our guess is that he is a winning investor.

Media Coverage

The media treatment of  business news reflects many questionable concepts.  The Business and Media Institute, which audits media coverage of the free enterprise system, writes as follows:

According to a survey by the National Council on Economic Education, 79% of Americans get the majority of their economic information from television. The study determined that an astounding 61% of the general public could not answer questions about basic economic concepts.

The BMI recently released its assessment of "The Media's Top Ten Economic Myths of 2007."  In an article well worth a complete reading, they give examples of media coverage and contrast with some solid data.

Their choice as the #1 Myth of 2007?

  1. The U.S. Economy is in recession.

This conclusion will be a familiar one for regular readers of "A Dash."

Timely Investment Implication

The most important current issue for investors is the extent of housing problems and the implications for credit markets.  The various housing issues -- potential foreclosures, ARM resets, teaser rates, lack of liquidity in structured mortgage products, faltering demand -- have all been extensively documented.  While some of the data cited by pundits are open to question, the existence and general magnitude of the problem have been well documented for anyone paying attention.

The potential solutions are a completely different matter.  We do not know which of the various proposals might work, nor the extent of the effect.  Most bearish pundits focus on the idea that proposed solutions are not comprehensive.

That viewpoint is quite correct, yet unhelpful.  Various government agencies (state and federal) are working to address parts of the  problem.  We do not yet know how successful they will be.  Since the market is estimating the effects as near zero -- note especially the reaction to the Fed's TAF facility -- the investor gets a favorable risk/reward.

Government is slow to implement change, much slower than markets would like.  Plans are floated as trial balloons, and implemented on a test basis.  If the plans work, more will follow.  If they do not, something else will emerge.  This is the nature of our democratic and pluralistic governmental process.

This is the history of solving problems.  It is very difficult to invest on the idea that partially known or even unkown solutions will mitigate known problems.

That is why it is so profitable.

Comments

[Victor Wilson]

Bear writing is just more fun to read. Kind of like an escapist novel. Anybody remember the "Crash of 84"?

VW

[Mike C]

"Married to a bearish view" and "making money" weren't mutually exclusive in 2007, it seems, despite Hussman's underpeformance (again) in 2007. BEARX up more than the S&P 500, +11.3% at last check. Heck, even GRZZX is outperforming Hussy and the S&P 500!

I wanted to make this point so my position is clear for future reference. I think there are things Hussman is very right about, but at the same time there is something broken in his model IMO.

I think he is absolutely correct about aggregate market valuations (earnings should be normalized for the business cycle), but again my thought is valuations don't matter for returns over a couple of years.

Clearly, his model for determining "market action" doesn't work. No system will be 100% correct, but it is a fact that his has been 100% wrong the last 4 years on "market action" as he has pretty much been fully hedged the entire time, and every 5-10% drop so far has been a buying opportunity before a subsequent advance. If his "market action" variable worked at all, there should have been times he was partially hedged instead of fully hedged.

My own technical indicators are mixed but firming up, and I think the possibility of 2008 being a strong up year is increasing, especially if the Fed is absolutely committed to flooding the system with money and liquidity (which likely is extremely bullish for precious metals in 2008).

My position in the fund is a very small one, and I don't plan on adding any new money until my own technical assessment goes negative.

[Mike C]

"If taking out the highs goes without saying, why wouldn't taking out the LOWS go without saying?"

If the market hit new highs, would anyone seriously try to argue that despite new highs, it is really a "bear market"? I wouldn't. However, if the market took out the lows, don't you think it would be EASY to find numerous people arguing that it was in fact NOT the start of a bear market, but just a bull market dip/correction? Maybe a market hitting new highs is self-evident as far as being a bull market, whereas a market taking out a previous resistance level isn't self-evident as to being the start of a bear market which is why one case goes without saying while the other case is worth mentioning? FWIW, the above are rhetorical/food for thought questions.

"Kudos to you for making some coin despite having a negative POV on the economy and the overall stock market, during a year when both were up!

At the end of day, it is about making money, right? .....................

And keeping those gains during tough markets?

Everything else is cocktail party chatter. Maybe interesting, mentally stimulating discussion, but not relevant to growing one's investment account.

[Bill aka NO DooDahs!]

If taking out the highs goes without saying, why wouldn't taking out the LOWS go without saying? Our choice of language exposes us ... a person with a truly neutral POV would have recognized both sides of the coin, or stated neither ... you explicitely stated ONE side of the coin.

"Married to a bearish view" and "making money" weren't mutually exclusive in 2007, it seems, despite Hussman's underpeformance (again) in 2007. BEARX up more than the S&P 500, +11.3% at last check. Heck, even GRZZX is outperforming Hussy and the S&P 500!

Kudos to you for making some coin despite having a negative POV on the economy and the overall stock market, during a year when both were up!

[Mike C]

FWIW, I think you are interpreting alot more into my words then what is there. Obviously, if the HIGHS are taken out, the bull market is still intact. I figured that went without saying.

For the record, in 2007, my portfolio has ***mostly been invested long stocks and stock mutual funds***. The cash position has fluctuated between 20 and 30%, and I've had a extremely small allocation to index puts, and a small allocation to one of your favorite hedged mutual funds. :) I'm substantially ahead of the S&P 500 for the year (up 13% YTD). Odd if that makes me married to the bearish view.

IMO, one should always being cautious and aware of negative possibilities, but that doesn't mean sitting 100% in cash or going 100% short. It simply means being on guard to protect against substantial losses. The mathematics of compounding dictate that avoiding large losses is critical to long-term success. A 30% loss requires a 43% gain to break even. A 50% loss requires a 100% gain to break even.

[Bill aka NO DooDahs!]

It seems you ARE married to a bearish view, Mike C., because you ask if the recent lows will hold or be taken out, but you don't mention the possibility of the HIGHS being taken out. "Caution" in and of itself is a result of focusing on negative possibilities.

:-0

[Mike C]

"There is only one side to the stock market;....not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock market speculation."

Jesse Livermore

Interesting point we are at right now. Are most of the "issues" that both bulls and bears bring up nothing but noise and fodder for cocktail discussion? Are they relevant to valuations, earnings, corporate profit margins? Valuations look reasonable, even good on forward estimates, but on P/S ratios *extremely* elevated. The market is stuck in a trading range. Which way will it go? Will the August/November lows hold or be taken out decisively? Time will tell. In the meantime, I intend to stay flexible and not get married to either a bearish or bullish view, but simply cautious and long stocks that are undervalued.

[Aaron]

Jeff,

Great material! I think you are spot on when you say that the problems are known but the solutions aren't yet, even though in the U.S. economic outlook there usually are solutions that come fairly quickly. The bears sure can pile on quickly, its amazing what a few down weeks can do!

[Bill aka NO DooDahs!]

I addressed the post with one of my own.

http://www.billakanodoodahs.com/2007/12/keeping-perspective/

I enjoyed yours and Paul's posts!

[oldprof]

Tim --

We all know that the toughest trade is usually the best trade. Despite that, when it comes, few can pull the trigger.

Thanks for the comment and for the good work on your blog.

Jeff

[Tim]

Jeff, the current prevailing pessimism about the credit problem, recession, home values, inflation, energy prices, yada, yada, yada, tends to make me quite optimistic about the fortunes of stocks of well run companies. First though, after reading all of the negative commentary, I have to really do a mental readjustment towards the positive, the negative just seems to feed the psyche. A good point about checking on old news to see what the problems of the times were. Probably only have to go back a few years and check of the on the outcome of the major fears at that time. Stay Positive! Tim