Why the market bulls have got it wrong - again

By Associate Editor David Stevenson Jan 08, 2009

David Stevenson

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Wall Street bull

Don't trust the bulls

This being New Year, every stock market pundit worth his salt – and also a few whose views maybe aren't quite so highly valued – has been having a bash at making predictions for 2009.

So I've glanced across the Atlantic to find out how the massed armies of analysts and strategists see the next twelve months panning out for share prices.

And, would you believe, the consensus opinion is very definitely bullish – but with a couple of very notable exceptions. Which makes you wonder just who's got it right…

Most 'experts' are optimistic, but I'd listen to the exceptions

Like it or not, what happens on Wall Street still makes the investment world go round. And the 'experts' are optimistic – almost exclusively. Scarcely an hour seems to pass without another upbeat note thudding into my inbox, with the forecast increases in America's stock market indices ranging from modest gains to a near 50% upswing. The average forecast for the S&P 500 in 2009 is a rise of 17%.

As Lynn Thomasson of Bloomberg highlighted a couple of days ago, the same Wall Street strategists who told investors to buy stocks in 2008– the worst year since 1937 – are even more bullish than a year ago.

But not everyone's quite so sanguine; there are some standout exceptions. And what's particularly interesting is that, as money manager Eric Roseman points out, they happen to be the "only two Wall Street investment strategists who accurately predicted the bear market that began in 2007. One is Merrill Lynch's David Rosenberg and the other, Joseph Battaglia at Stifel Nicolaus".

In another difference to the mainstream, their long-term track records are pretty good, too. "I've followed the careers of both market seers over the last 20 years and have a deep respect for their market views and prescient forecasts, usually right on the money", says Roseman. "Battaglia was the first Wall Street veteran to warn in August 2007 that subprime would morph into a full-blown credit crisis, and advised investors to avoid stocks and bonds and head into cash".

Sounds well worth a further look. As a natural cynic and instinctive contrarian, I'm always tempted to take a different view to the prevailing consensus. What these two gentlemen are now seeing in the market tea leaves could easily be a lot more useful than all those other bullish opinions.

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This isn't a normal bear market

Battaglia's still very cagey on the economy, despite the widely-shared view by other investment strategists that there'll be a second-half rebound based on President-elect Obama's massive government spending programmes and quantitative easing – i.e. printing money to buy US Treasury debt.

Heavily indebted consumers will stay under the cosh, and jobs will be cut savagely. Yesterday's data saw the pace of payroll cuts by private employers accelerating even faster, "threatening to send unemployment to levels unseen in a quarter of a century," reports Bloomberg. But the real key to an economic upturn is the housing market. And Battaglia doubts that American house prices - down over 23% in the year to October, according to the S&P/Case-Shiller Index of 40 cities - will bottom out this year.

As Roseman says, all this points to the bear market rally we've seen since the November 20th low, which took the S&P 500 Index back down to 1997 levels, proving yet another in a series of traps for investors - just like every earlier rally since late-2007 which has then been met by new waves of selling.

Although markets have historically managed to recover in the face of bad economic news, this isn't a normal bear market - it's a credit-inflicted crisis that will take more time to heal. This bear market is totally unprecedented because virtually nobody alive can remember the devastation caused by the last credit bear market of the 1930s. Investors are continuing to underestimate what a full-scale credit unwinding really means.

How can investors be bullish on shares in conditions like these?

What's more, investors haven't worked out yet how extra government intervention and regulation will affect capital markets. How can investors can be bullish on shares when the government owns a fair chunk of GDP (finance, housing, cars) and will introduce a new salvo of securities laws restricting capital innovation, leverage and overall finance?

Rosenburg sums it up like this: "No strategist in the latest Barron's Roundtable – a well respected financial discussion forum - is calling for another 'down' year in shares. We had this exact-same situation a year ago when the Roundtable forecast was 1,640 on the S&P 500 for the end of 2008. It closed at 903 – the experts as a group were only off by 45%".

Household wealth is being destroyed - $13trn so far and counting – faster than ever before, completely dwarfing the $2trn the US Federal Reserve is pumping into the economy. So expectations that the Fed, Treasury or Congress have some magic wand are wholly unrealistic. At best, what they're promising to do will just lessen the damage.

"If history's any guide, this cycle of deflation – falling prices – could have another two years to run. It's amazing what a 20% bear market rally does to alter perceptions about the entire year ahead. But the risk is that consensus will be wrong yet again."

In other words, don't be fooled by short-term share price rallies. The latest is likely to end in tears, too…

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Published in Economics | More articles by David Stevenson

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