Are We Heading for a New Bear Market?

I read somewhere once where Ben Franklin felt that he was not qualified to debate someone unless he understood his opponent's arguments better than they did.

With Ben in mind, and after re-reading some of my recent somewhat bearish posts on the world and the economy, I thought I should lay out some of the reasons that we might not be heading for disaster.

After a difficult second quarter (the S&P 500 dropped by -15% from its peak in mid-April), it is hard not to feel bearish on the markets. The S&P's performance was the worst since the final three months of 2008.

In addition, gold continues to move higher, rising +12% over the last quarter to a record $1245 per ounce (Gold ETF's, by the way, are now the second largest ETF's in asset size, with roughly $50 billion in assets). Gold is telling us that investors are fearful of inflation or government policies, or both.

Interest rates have moved sharply lower. The 10 year Treasury note now yields about 2.95%, or more than 100 basis points lower than just three months ago. Two year Treasury notes yield 0.6%, which represents their lowest yield - ever. Clearly there is a "flight to quality" mentality in the bond market.

Technically the market looks vulnerable as well. Goldman Sachs put out a research piece yesterday saying that if the market broke lower through current levels (around 1030 on the S&P) the next stop is 24% lower.

That's where we are. So where do we go from here?

I listened to two bullish strategist discussions yesterday, and have read research pieces from a few other sources. Most seem to feel this is simply a pause in the market, mostly due to the fact that their data would suggest that stocks in general, and large cap stocks in particular, are priced attractively.

Another piece of the bull case rests on the continuing good news from the emerging markets. True, it looks like China's growth rate might be slowing, but moving from +10% quarterly GDP growth to +8% hardly seems like a disaster. Today's New York Times carried an article discussing the strong growth in Latin and South America, particularly in Brazil.

Other bullish signals (via Merrill Lynch): strong corporate productivity gains; disciplined corporate capex strategies; manufacturing remains strong; healthy corporate balance sheets; and lower US interest rates.

Finally, most strategists would suggest that the fact that the general public remains skeptical of stocks means there could be considerable buying power if the market stabilizes. With money market rates stuck at 0%, it wouldn't take too much to convince investors to move at least a portion of their savings into the market.

I obviously hope the bulls are right. However, I also think that the bond and commodity markets are sending us messages that we might not want to hear. In addition, as I have written in numerous posts over the last couple of weeks, I am convinced that policy makers are making a huge mistake in raising taxes and cutting government spending at a time when growth is still anemic.

Stay tuned.