In a recent piece called “Green Shoots Have Arrived,” Barclays’ chief economist Larry Kantor argues the current rally is the start of a bull market and investors should be exposed to equities. I am not sure I agree.
Kantor’s argument is based on two key points. First, he writes that the market is incredibly pessimistic and has absorbed all bad news. His support for this statement is that earnings estimates are now on average 95% down from their peak. Whether this number is right I cannot say; however, I do not think such a drastic change in earnings is yet reflected in market prices, especially not with this recent 20% rally. (This probably was the case on March 9. Interestingly, the FT’s March 10 short view embraced the idea of a “revulsion phase.”) Also, I doubt the market will respond positively to terrible Q1 earnings, even if analysts have anticipated them. As I learned from football, it feels a lot different to know you are going to get hit than to actually get hit.
His second argument is that there was been a “massive inventory correction.” On this point I do not disagree.
But this time it’s different. Why would companies build up inventories again if there is no demand? Richard Koo coined the term “balance sheet recession” to describe the unique Japanese situation of the 90s. In his words, “Balance sheet recessions are highly uncommon and happen following the bursting of a nation-wide asset price bubble...This type of recession is unlike other recessions in that the inventory cycle is not the key driver. The key driver in this recession is the corporate effort to repair their balance sheets by postponing investments and instead, paying down debt. When a large number of companies move away from the usual goal of profit maximization to debt minimization all at the same time in their effort to regain their financial health, the balance sheet recession starts.”
Though there are many stark differences between
This is clearly not a v-shaped recession. There are some surprising similarities between stock performance in the first 100 days after a trough during recessions. As is evident in the charts below, there is a significant difference between stock performance during deep recessions and mere downturns. The top chart is stock performance after a trough during deep recessions, including 1929, 1974, and 1982. The bottom chart displays stock performance during recessions that weren’t as pronounced economically and often had greater importance financially, for example 1987. Ironically, stock performance is greater in the deeper recessions.
Since equity markets recovered faster in the bottom downturns than the top recessions, these charts support that the current gains are a bear market rally. Below is another useful chart from the NYT to keep in mind:
However, though the economy is far from recovery, US stocks could provide decent returns in the short run. In his famous book Stocks for the Long Run, Jeremy Siegel shows 75% of big gains or losses in the market have no rational justification. How important are big gains or losses to overall performance? Javier Estrada from IESE “found that if you took away the 10 best days, two-thirds of the cumulative gains produced by the Dow over the past 109 years would disappear. Conversely, had you sidestepped the market's 10 worst days, you would have tripled the actual return of the Dow.” You cannot afford not to be exposed to these gains, especially considering the biggest gains follow a big fall. The market is hopeful and eager. To earn a good return in the short-term, i.e. within 2009, trust in the same irrationality that brought the markets to this point in the first place.
Sources:
Balance Sheet Recession by Richard Koo
http://www.bythefault.com/2009/01/17/more-evidence-of-a-balance-sheet-recession/
http://www.calculatedriskblog.com/2009/03/inventory-correction.html
