A reader recently responded with several excellent reasons why this could be the formation of a major market top and what Robert Prechter referred to as the next leg down in the bear market. Although I turned near-term bearish recently, I am not convinced that this is a major turning point. In this piece I respond to “Our Man In NYC” and the reasons why I believe this is not a major market top, but more likely a correction within the uptrend:
Our Man In NYC:
Thanks for the great response. I’ll give you my brief thoughts on each topic you touched on.
– CRE: Still a huge problem, but it’s a slow motion train wreck. The majority of the troubles in CRE are spread out over the next 3 years and will hinder bank balance sheets, but won’t serve as the “all at once” wallop RRE was in 2008.
– RRE: I said that last years stability in housing was a head fake and I still think we’re heading lower, but the stimulus will continue to bolster prices in the near-term. There will be one last surge in activity as the tax credit ends this year. Late 2010 and 2011 has potential for substantial declines in residential as resets surge, foreclosures remain high, inventory remains high, stimulus ends and the laws of supply and demand reassert themselves after the government’s temporary price fixing. The next leg down isn’t quite here yet.
– Sovereign Risk: Greece is getting bailed out in all likelihood, but all in all, another slow moving iceberg. The S&P story on the UK is alarming. As readers know, I think debt is why we’re ultimately still in a bear market, but it’s not a NEAR-TERM concern.
– Liquidity: The Fed remains accommodative. China appears to be on the verge of a wind-down. Alarming, but at 10.7% GDP I think investors will ultimately view the near-term downturn as a buying opportunity in emerging markets. Stimulus and accommodative policies are nearing an end, but the process will remain lumpy as the U.S. keeps rates near zero for all or most of 2010.
– Terrorism: Agreed. Always a risk. Not an investable/foreseeable event, of course.
– China: Still showing strong growth. Not quite a bubble yet in my opinion and substantial downside should be viewed as a buying opportunity.
– Trade/Protectionism: Not the negative many would like to make it out to be. This global economy is too intertwined for 1930’s style protectionism to develop.
– Valuation: Primarily a rear view mirror indicator. So long as earnings continue to outperform the market will look cheaper than investors currently assume. Not a reliable indicator of future price action in my opinion. The PE is one of the most misunderstood and unreliable indicators investors have ever used.
– Deleveraging: A slow motion train wreck. As regular readers know, this is one of the primary reasons why the bear market is still with us. However, as we saw in Japan, stimulus and government spending thwarted major downturns for prolonged periods of time. The stimulus in the U.S. isn’t over yet.
Comments and coherent responses are welcome/encouraged.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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