Bulls Vs. Bears - Here Are Their Cases

Would you believe the market finally had a decent week? Long overdue, the S&P managed to end the week up by 4.6%...the first respectable gain since early August, and the only the gain of any size since mid-September. 

Here's the big question though - is more of the same on the way now that the bulls have been nudged? That's what we're going to look at today.
 

The Bullish Case

The big gain last week is the best argument the bulls have right now. The weekly gain was actually the biggest in years, and nothing speaks more loudly about future results than current results. 

On a similar note, it's interesting how the bears had a big opportunity to drive the market even lower following Monday's huge gain. They did for a couple of days, but the market caught itself before its prior lows were retested. Either the bears can't or won't start another round of torture. 

Also, the credit freeze? It's beginning to thaw out. The often-discussed TED spread (essentially the difference between what it costs banks to borrow and what it pays them to lend) is starting to close to more healthy levels. Just to be clear, it's still wildly high. But, if it at least looks like it's shrinking, that could be enough to inspire investors back into the market. 

And finally - and this isn't a joke - there may not be many shares left to sell. Volume, breadth, and depth have all hinted of selling exhaustion, and cash positions are almost as high as they were in late 2002. Sure, it's a case of "bullish by virtue of not being able to be bearish", but it worked in early 2003. (Check the blog in the coming week as we detail some of these details.) 

It doesn't hurt that Warren Buffett gave his endorsement of U.S. stocks on Friday ...though it didn't seem to help a great deal either. 
 

The Bearish Case

If you drop anything from high enough, it'll bounce. Let's not forget that two weeks ago the S&P 500 fell 15%...the biggest weekly loss ever. So, to see the bulls push back this much isn't entirely unexpected. As with the bulls, the bears are watching the coming week intently - their party may not be over yet.

If for some reason the recent lows of 840 don't hold up as support, it may well trigger the next wave of selling. 

We're also about to head into the heart of earnings season. Needless to say, profits may be a little thin this time around. We believe most of any earnings problems are already priced into stocks, but that doesn't mean an earnings miss won't shake out some of the few lingering owners of any particular holding. The average investor still seems to see the glass as half empty.

And lastly, the bears can make the argument that over the last few weeks, any progress made in the latter part of any week is largely wiped away on Monday of the next week. Last Monday's 11% rally was an exception; the prior three Mondays were all disasters. Maybe last week broke the streak - we'll see. If last week was indeed an exception to the trend, plan on seeing a lot of red early next week. 
 

What About Fundamentals?

At the risk of sounding flippant, since when did fundamentals matter? 

OK, the rhetorical question was mostly for effect, but you get the point - this mess isn't really about fundamentals. If it were, the market would have recovered two weeks ago when the S&P 500's forward-looking price/earnings multiple was around 10.0. That's cheap by long-term standards, yet we saw those same stocks get even cheaper.

No, this mess is about our old friends fear and greed. As inexpensive as stocks were at the very beginning of October (forward-looking or current), investors still had serious doubts about companies being able to even meet their lowered expectations. And for good reason - the credit market really had seized up. As a result, the market continued to sell off until that average projected P/E sank to about 9.0, where things seem to have stabilized. 

So to answer our own question 'what about fundamentals?', the values are great right now, even if corporate performance is merely mediocre over the next six to twelve months. Values, however, don't always translate into rising stocks. 

And that's the key to it all - when will stocks rise because they're undervalued? Until they do, the expected P/E of 9.0 and the trailing P/E of 18.6 (which is also under the five year average) are irrelevant. 

Our point is, this past week may have been the beginning of such a move - we're certainly ripe for it. But, only next week will let us know if things will actually be the way they 'should' be. Ideally, we'd see a move above this past week's high of 1044 for the S&P 500 to say the rebound is materializing. We can't count on it happening though....not yet. 

Stay tuned - we'll be watching it closely, and will send you an update you next week. 

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