Wednesday, October 17, 2012

Richard Bernstein: We Are In The "Third Inning" of a Bull Market

The S&P 500 is just 0.7% short of the best close since 2007.  Housing and auto sales continue to surprise analysts on the upside. Even unemployment rates are moving lower.

Yet the bearish sentiment continues unabated. Investor attitudes seem largely focused on the risks in the stock market rather than the fact that the valuation of stocks relative to just about every other asset class screen are at historic wides.

Former Merrill Lynch strategist Rich Bernstein looks at the current market environment and thinks we're in a confirmed bull market, as Financial Advisor magazine reports in its most recent issue (I added the emphasis):

With the S&P 500 up more than 100% from its March 2009 low of 666, many people are asking if the bull market is over. Bernstein cited the absence of three classic bear market signals—yield curve inversion, extreme overenthusiastic sentiment, and lofty valuation—as evidence the bull market is young. He guesses that "we are in the third inning." 

Wall Street remains as bearish as it ever was. Today, retail investors believe they have to buy everything that performed well in the last decade—gold, emerging markets, emerging markets debt, REITs and hedge funds. All these asset classes boomed in the so-called lost decade between 2000 and 2008 at the same time as the credit bubble was inflating. 

Institutions continue to allocate major parts of their portfolios to hedge funds and private equity. Even though they can't keep up with stocks, institutions are "paying 2 and 20" to chase the last decade's returns. 

In 2002, everyone was asking "when to get back into tech stocks," Bernstein said. "It's hard to argue stocks are overvalued when the 10-year Treasury yields 1.7%."

Bernstein, by the way, is not your typical wild-eyed optimist.  Indeed, he lost his position with Merrill in 2007, when he refused to back down from his conviction that stocks were poised to move lower (never a good idea to tell investors to sell stocks when you work at a brokerage company!).

Part of the problem in today's market, I think, is that while growth trends may be moving higher, they are not accelerating at a pace that would create the feeling that the economy is doing anything but sputtering.

For example, Washington Post columnist Annie Lowrey noted on Twitter this morning that while housing permits are trending higher, they remain mired at a level no higher than they were in the winter of 1991.

In other words, while the housing numbers are positive, the absolute numbers remain historically low.
However, while I am not as optimistic, I think that Bernstein is probably right.  The conditions that would lead to a major market correction - tightening credit, overdone bullish sentiment, and high stock valuations - are not evident at this point.

Meanwhile, interest rates continue to creep higher.  If investors in bond mutual funds find that their investments in bond funds are losing value as rates rise, we might see a reversal of the stock to bond fund swap that we have seen over the past 5 years.