A great debate is raging over the recent 30 to 40 percent rally in most major stock indexes since the lows set back in March. Those who are pessimistic maintain that the recent rise in stock prices is doomed to reverse course soon and that prices will decline again, perhaps to levels even lower than before. This scenario is called a bear market rally – an unsustainable rise in prices contained within a larger downward trend.
Those more optimistic believe that, eventually, after major declines, new bull markets are born which may last several years. The recent dramatic rise in stock prices, albeit after a very severe decline, already qualifies as a new bull market since it has risen in excess of 20 percent from the lows of early March.
As you might have guessed, a lot of this is semantics and opinion, with the ultimate assessment of who is right only taking place when hindsight becomes the final arbitrator. If I say this is a new bull market since it has risen more than 20percent from the low point, I am right under the textbook definition. Those in the bear camp would say we can’t prove it’s a new bull market until a new high is set for the major indexes. The problem is that waiting to invest until that happens means you will have missed a 100 percent rise in prices (the recovery required to get back to new highs after a 50 percent decline like we sustained from the fall of 2007 to the spring of 2009).
My opinions aren’t right much more often than anyone else, so we rely on a set of quantitative rules to make adjustments and attempt to control risk in our clients’ accounts at my firm. Since April 7, that set of rules is giving a positive signal for stock prices. That doesn’t mean that further gains are guaranteed, but we believe there is a good chance for further gains over the remainder of 2009. We expect corrections along the way, and there is always the possibility our model may give a sell signal, causing us to change our outlook and portfolio allocations.
I think you have to be a little cautious if you are of the opinion that stock prices will decline substantially looking out over the next several years. It certainly could happen, but after major declines, there is more history of recovery than of continued turmoil. Being bearish also requires that you face the headwinds of history. The facts are simple – in the long-run, stock prices have always risen despite periodic declines, some of which are severe. Unless you believe our economic system has fundamentally changed and will never be productive again, you should acknowledge that the next decade has a reasonably good chance to provide positive returns.
My reasons for thinking we have started a new, potentially lasting rise for stock prices is based on our indicators as well as a qualitative assessment. The decline in stock prices in 2008 was directly linked to the credit crisis impacting the sub-prime mortgage and corporate bond markets. These credit markets have been rising in dramatic fashion, like stocks, and I believe as long as we continue to see improvement in the corporate credit markets, we can see a further rise in stock prices.
As always, my opinion or anyone else’s may be wrong, or events may transpire in the future that make us reassess our view. Smart portfolio management involves taking acceptable risks for your personal situation. One of the most successful fund managers I know, Jean-Marie Eveillard, of the First Eagle Funds, makes every investment decision with one main thought in mind, "The future is uncertain." Just when we think we have it all figured out, whether bullish or bearish, it’s probably going to change soon, and we need to be ready.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.