Will stocks go up when they should go down? Independent Financial Advice
Posted by Don Martin on Tue, Jan 10, 2012 @ 07:05 PM
How the bear case could be wrong
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The stock market is overvalued using the PE10 formula. It needs to go down to 800 points for the SP500. And some bears claim it needs to go to 450 for the SP500 to reach fair value. However the stock market rarely is logical.
What is a contrarian way that the bears could be wrong?
If the marketplace fears inflation and feels that commodities are a bubble that incurs carrying costs then some investors may decide that stocks are a place to park money to avoid the effect of inflation. I don’t believe in that argument, however, if the masses of investors make an emotional decision to believe in it then they could use that as an excuse to overpay for stocks in an attempt to avoid a crash in the bond market caused by inflation. (I don't believe inflation is coming back in the near term). Assuming that China, Europe and Japan all have problems that will get worse then capital will flee to America and the flight will make Treasuries go higher, thus reducing interest rates, thus motivating investors to seek a 2% yield on stocks instead of a below 2% yield on ten year Treasuries. The rally could then trigger an irrational wave of momentum buying of stocks.
The problem is that ultimately the truth comes out and the market adjusts to a correct view. If a stock’s PE is too high then eventually it will go down. If the whole world except the U.S. suffers from economic chaos the problems would spread into the U.S. and corporate profits would plummet. The world economy is too integrated to have a bona fide long term decoupling where one country becomes an economic paradise while the rest of the world goes into crisis. Eventually the world economic crash would reach a bottom where investors would want to start investing in Europe, Japan, China and they would pull out funds from the U.S., thus causing a crash in U.S. stocks. So even if I’m wrong about my bearish view for 2012 I still think any U.S. stock rally in the current market conditions of 2012 is incorrect and would be an irrational emotional leap of faith.
Remember the bubble of 1998-2000 where the bears said the stock market was too high but the market kept going up. Bubbles can last for years and can keep getting bigger beyond any reasonable limit.
I wrote an article “Three bear market strategies you must know”.
Investors should seek independent financial advice.