Comstock Partners, Inc.
New Secular Bull Market or another Fake-Out?
The headlines in all the various newspapers tell the same story. Barron's had a cover story this weekend, "STOCK ALERT"! GET READY FOR A RECORD ON THE DOW! This was followed up with their past predictions of Dow 14,165 in October of last year, and they expect a breakthrough of the old record high soon. They expect the Dow to reach 15,000 or more this year, as a "huge amount of money that could shift into stocks because individuals, until recently, have favored bonds over equities based on mutual funds data." They go on to explain the large shift into stocks as there is "nowhere else to go". There were many other headline stories in newspapers about the big shift from bonds into stocks that is expected to take place this year.
It seems to us as more reminiscent of the other major financial manias that took place in the late 1990s (the dot com bubble with many over the counter (OTC) stocks trading at 300 times earnings), and from 2003 to 2007 (where the housing and stock market bubbles were initiated by the Fed lowering the Fed Funds rate from 5.25% to 1% in mid 2003). These were similar major bull market moves, only to be followed by market collapses in early 2000 and late 2007.
This time the Dow broke above 14,000 where it was last seen in late 2007 and traded at the record of 14,198 in October of 2007. This is just a little over 1% from the all time high and up 114% from the low in March of 2009. The S&P 500 after reaching 1513 last Friday, hasn't been that high since late 2007 and is just 4% away from its all time high of 1576 achieved in October of 2007. Also, the 5% gain it achieved during January was the best January gain in the S&P 500 since 1997 (many analysts believe that increases in January, especially large ones, are precursors for stock market gains for the year). The NASDAQ is up 150% from its low in 2009 and 37% away from its all time high of 5132 in March of 2000.
These gains are very impressive, but the gains following the dot com bubble and the housing bubble were just as "impressive" and we believe this major market move will end up being just as disappointing as the other two. Even though we don't have the bubble characteristics of the other two manias, we do have an enormous debt problem that seems to us to be intractable. In fact, we wrote about our debt difficulties many times in the past usually showing how the private debt would continue declining while the government debt increases would offset them to a large degree (chart of public vs. private debt is attached-and was first published by us in July of 2010). As a matter of fact, Paul Krugman wrote about this in an editorial in the NY Times a couple of weeks ago. We rarely agree with Paul Krugman, but in this case he was making our point. He stated, "It was, in fact, a good thing that the deficit was allowed to rise as the economy slumped. With private spending plunging as the housing bubble popped and cash strapped families cut back, the willingness of the government to keep spending was one of the main reasons we didn't experience a full replay of the Great Depression."
The household debt for the third quarter of 2012 was just disclosed and we now have the 16th quarter of decline, while only increasing for 2 quarters since mid 2008 (attached are 2 NDR charts on H/H debt and H/H debt statistics). We believe that the only thing holding up this economy has been the government spending, but this is now changing as most of you witnessed in the release of 4th quarter GDP for 2012 at -0.1%. The main drag was government spending which dropped 22.2% for defense (the worst since 1972), and government spending overall dropping 6.6% (the worst since 1st quarter of 2011).
So, we had to hope the government sector would offset the weakness we continue to expect in the private sector, but now it looks like the government sector is not going to be the pillar of strength we thought it would be. And if the sequester is triggered in another couple of weeks the economy will almost surely enter a recession if government spending continues contracting as defense is cut in half and discretionary spending is cut sharply. Remember, in the latest "special report" every dollar of government spending decline takes $1 away from GDP. Even if there is a "grand bargain" achieved in Congress the bargain will surely raise taxes and cut government spending. Naturally, government spending has to come down sharply over the long term, but with all the debt we have presently, sharp cut backs now could be very detrimental to the economy. We need to get economic growth going again before we can cut government spending and that puts us in a box that seems very difficult, if not impossible, to extricate ourselves out of.
It is this dilemma we find ourselves in, and why we believe this major bull run is going to wind up being a "fake-out" move where the markets will decline as much as they did in 2000 and 2007, or even more. To show you the way we felt in late 1999 before the bubble burst in early 2000 we wrote, "Feet Don't Fail Me Now" (this can be found on our home page). Below you can find in the archives the reports written before the bubble burst in 2007. You can find these by clicking on any of our recent comments and scroll down the right hand side of our home page to the "Archives"-there you can find the reports by typing in the archives the title below.
12/10/99 Feet Don't Fail Me Now---- on the Home Page -Scroll Down left hand side
02/08/07 The Housing Noose is Tightening
02/01/07 Market Still Highly Overvalued
05/31/07 The Hard Landing is Here