Is the U.S. stock market close to bottoming?

After another brutal day in the market, whether the market is bottoming does not seem like the question on most people’s minds. Ten stocks declined for every one up today — and on heavy volume. Retail investors are clearly switching into cash and bonds judging from the recent price action. Yet, an increasing number of long-time bears are becoming ever more bullish as the market declines. Witness famous investor Steven Leuthold.

Steven Leuthold, whose Grizzly Short Fund makes money for investors by betting companies will fail, says he wouldn’t invest in his own fund now because the U.S. stock market is close to its bottom.

Leuthold, who helps manage $3.2 billion as founder of Minneapolis-based Leuthold Weeden Capital Management, told investors to keep money out of the Grizzly fund yesterday after it rose 74 percent in 2008. He joined Bill Fleckenstein, who shut a 13-year-old bearish fund in December, and Marc Faber, who covered bets against U.S. stocks.

The 54 percent plunge in the Standard & Poor’s 500 Index since October 2007 gave the average short-selling hedge fund a 28 percent increase last year, the most among strategies tracked by Chicago-based Hedge Fund Research Inc. Leuthold says the S&P 500 may rise 40 percent this year because the U.S. economy won’t fall into a depression and stocks are the cheapest in 24 years.

“I personally would not have an investment in the Grizzly fund because I think we’re so close to a major market bottom,” said Leuthold in an interview with Bloomberg Television from Tucson, Arizona. “Every investor ought to be considering putting money into equities.”

Short sellers borrow stock and sell it with the hope of profiting by replacing it after prices fall. The number of shares held short on the New York Stock Exchange has fallen 26 percent from a July peak.

Edward here. Leuthold is not the only bear turned bull. On Monday, I mentioned that Bill Fleckenstein was bullish on Gold in the article Fleckenstein: Protect yourself from Financial Armageddon with gold, the corollary being he is probably bearish on stocks. But is that really true?

Fleckenstein, president of Seattle-based Fleckenstein Capital Inc., says that while stocks may advance in coming months, they’re likely to lose the gains as the recession worsens and unemployment climbs.

The 55-year-old investor, who plans to open a fund that bets on both stock declines and gains later this year, said if he were managing a fund today he would be “doing a whole lot of nothing” and would have few short sales.

“Just because the market is going down, I don’t necessarily feel I want to put my capital at risk if I can’t find ideas that make sense,” said Fleckenstein. “It’s kind of dangerous to be shorting even though it’s working.”

Fleckenstein said he boosted his stake in Redmond, Washington-based Microsoft Corp. yesterday as the world’s largest software maker traded at 8.5 times profit, the cheapest since at least 1987. Microsoft added 1.5 percent to $16.12 yesterday after losing 73 percent of its value since December 1999.

So, let’s call Fleckenstein a bull here. I reckon he is not bullish on everything, but sees a number of value plays that a discerning investor could have, Microsoft being an obvious one. But, not everyone is so bullish. David Tice of the Prudent Bear Fund sees danger ahead.

The size of the stock market’s losses over the last 16 months is fooling investors into buying, according to David Tice, the chief portfolio strategist for bear markets at Federated Investors Inc., which manages $407 billion including the $1.1 billion Federated Prudent Bear Fund. Tice said in February that the S&P 500 may decrease as much as 50 percent this year.

Rounding out the article is another famous Bear, Marc Faber. He seems to be bullish, if only for a technical bear market rally.

Faber, who publishes the “Gloom, Boom & Doom Report,” said in a Feb. 23 interview on Bloomberg Television that investors shouldn’t short stocks because programs by the Federal Reserve and Treasury may ease the recession in the next three months. The U.S. government pledged more than $11.6 trillion over the past 19 months to spur economic growth and bail out banks, according to Bloomberg data as of Feb. 24.

Faber, based in Hong Kong, didn’t respond to requests for an interview sent outside of normal business hours.

“I see the comments from my readers and a lot of them, they want to short the market,” said Faber, 63, on Feb. 23. “This is something I would not necessarily do.”

My own read here is this: markets tend to overshoot in both directions. This suggests that we will need to go well below fair value before this bear market is over. The price/earnings ratio on the stock market of 13 is near perceived fair value of 15 here. An overshoot could take us down to 500-600 on the S&P 500. Moreover, in 2007, corporate earnings as a percentage of GDP were at record highs, suggesting they were cyclically inflated, making those P/E ratios also inflated.

The long and short is I don’t think we are near bottom. We should see more downside before this bear market is over. However, I tend to think a bear-market rally is in the offing this year due to unprecedented stimulus. So, shorting might be as dangerous as Faber suggests, but indexing is equally dangerous. In the meantime, there are an increasing number of attractively-priced stocks out there as Faber, Fleckenstein and Leuthold can attest.

Leuthold Joins Fleckenstein, Faber Warning on Shorts –
Next Stop…Dow 5000? – Smart Money

  1. Econophile says

    While I agree with you, you are guessing. I think this is one of the problems with Wall Street: people guess when they don’t know it. Yes, I follow Nasim Taleb, von Hayek and their ideas on epistemology, which I believe you have studied. Caveat emptor.

  2. Terry says

    I, too, agree with you, but I’d add that I think we are now nearer the bottom than the top on either an absolute or percentage basis.

    At this point, my problem is less with valuation–some stocks are well worth looking at–than it is with the nature of any post-bottom (economic & market) recovery. Frankly, I think both will see either a very lazy “U” or a flat “L” recovery.

    The prospects for capital growth on the other side of the bottom over the next 3-7 years is just not that attractive. I would make sure that any investments made in the near future were not only in “good” companies, but ones that pay–and still promise to pay–good dividends. They are likely to be the only stocks that offer any kind of meaningful total return.

    I hope otherwise, but I think that’s where we are and where we’re headed.

    1. Edward Harrison says

      Terry and econophile, it is definitely just a guess on all our parts as to how much lower we could go because much of this has to do with investor psychology and the policy response to this banking crisis. Obviously, if the crisis does not stabilize, earnings will suffer even more and we could go much lower still.

      However, as Terry says, I do think we are much closer to the bottom than the top. I should point out as well that, even though I tend to take a macro top-down approach, my thesis has been for the past few months that the broader market is irrelevant. As stocks go lower an increasing number of opportunities are presenting themselves and one has to take a bottoms up approach and ignore the broader market in order to have the stomach to buy as everyone else is selling.

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