1) Why do bears always seem smarter than bulls?
This is a question James Altucher posed a few weeks ago. It’s an excellent question and he had some great thoughts on it, but I wanted to provide my own opinion. First off, I’ll admit it – bulls get a bad rap. For centuries the bulls have been right and they don’t get a whole lot of credit. In research circles parmabears have cult-like followings. Personally, I don’t think it’s due to any great brilliance. It actually strikes me as uniquely stupid to be a permabear. The truth is, economies grow and expand over long periods of time because human beings are evolving, growing in numbers and generally becoming more productive. Fighting these trends over a multi decade period is almost always going to be a losing endeavor.
But this doesn’t mean that secular bear markets can’t occur. As we’ve seen over the last decade persistent weakness in equities can and does happen. Economies can become overextended and bloated with excesses that take time to work off. I don’t like the fact that I am a believer in the current secular bear market. I know that it hurts millions of people. I know that America is worse off right now because of this environment. But I also know that this too shall end. So while I am a believer in this secular bear I honestly look forward to believing in the next secular bull. I am hugely bullish on America in the long-run.
But why do bears always seem smarter than bulls? Because, as I said above, it takes some gumption to stand up in front of these secular trends and proclaim that they will stop working in the near-term. Anyone can go on TV and say “stocks for the long-term”. Personally, I think investors appreciate the alternative perspective. We are force fed so much nonsense from the Wall Street sales machine every day that it’s refreshing to see a well thought out alternative perspective. People respect it and honestly, I think it’s a great service to provide an alternative to the constant “buy, buy, buy” mentality that has come to dominate Wall Street.
In a culture that has become epitomized by reckless spending, lending, and borrowing it’s refreshing to see that more and more people are returning to the idea of risk management and prudence. In sum, it’s not that bears are smarter – it’s simply that investors appreciate their uniqueness more than they appreciate the “stocks for the long-run” mentality that has failed so many for so long.
2) I haven’t been net short since the month before the flash crash occurred.
I believe there is a disequilibrium building in the market currently. “Buy the dip” and David Tepper’s “win win” market has come to dominate the market on a daily basis. Why am I bearish?
A) I believe the market is severely misinterpreting the Fed’s ability to generate inflation and economic recovery via QE. In fact, the historical evidence shows that there is no reason to believe that the Fed can generate an economic recovery via QE.
B) Most investors believe the upcoming election is a net positive for the market. They refer to some silly chart that shows past periods of gridlock and automatically conclude that this period will be no different. This reminds me of when you’re watching a sporting event and you hear the announcer say: “The Durham Bulls are 150-0 when leading in the bottom of the 9th with 2 outs.” Any logical person would say: “but wait, those 150 wins were accomplished with entirely different teams and unique situations.” There is absolutely no reason to believe that this period of time will be similar to any past period. In fact, I have argued that this period (balance sheet recession) is highly unique and therefore all back testing must be thrown out the window.
In a balance sheet recession the private sector will remain weak as they pay down debts. This has been proven true over the years by the weak PCE data. If government does nothing to bolster the economy there is a high probability that growth will contract. This is best visualized with the following graphic from Goldman Sachs:
With the inventory cycle ending and stimulus becoming a net drag on economic growth there is a very high potential that the consumer will fail to carry the economy out of the doldrums. Why does the election matter? Because gridlock will almost guarantee budget reductions and reduced government intervention. We can quibble over the effectiveness of government spending, but one thing is positively true over the last few years – government has been good to the market. The removal of government via gridlock increases the risk that the private sector will be exposed as weak as it was in 2007 and 2008.
C) Earnings have been very strong again and are largely reflected in equity prices at these levels. In each of the last 4 earnings season we have seen the exact same trend. Companies top analyst’s expectations and equities rally into and throughout earnings season and then sell-off when the catalyst subsides. This earnings season is setting up just like the last 4.
3) QE WORKS!!!!!
It’s become popular to cite the recent market rally, dollar decline and commodity rally as evidence that QE works. Of course, most of these investors forget that this rally did not start with QE (in fact, the market fell in August in the face of QE rumors). This rally started with the August ISM Manufacturing report that came in well above expectations. The market sentiment at the time was very depressed, deflationary and generally expecting a double dip. But better than expected economic data and strong earnings have largely alleviated these fears (in fact, they have been flipped entirely as investors are very bullish and believe inflation is right around the corner).
If QE has had any impact in recent weeks it has been 100% psychological. How do we know? BECAUSE THE PROGRAM HASN’T EVEN STARTED YET! How can anyone say that QE2 is driving the market higher when we know for a fact that QE2 is only having a psychological impact? In other words, investors have been readjusting portfolios in recent weeks on better than expected news and EXPECTATIONS that QE2 is some sort of wonder drug. I’ve argued that this is misguided and based on misconceptions that QE is inflationary (a misconception that a sitting FOMC member has finally admitted).
Thus far, there remain many question marks regarding QE. But the two things we can confirm thus far is that QE has not created one single job and that the market’s recent advance (if at all attributable to QE) has been due to gamblers betting on a positive economic outcome courtesy of the Fed. If QE actually works we won’t know it for several quarters. Unfortunately, QE has already failed in Japan, the UK and here in the USA. After all, if QE1 had created sustained economic recovery there would be no need for QE2.
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.