Regular readers of this blog know that I like to take reasonable contrarian stances; I don’t go against the crowd for the sake of it. That being said, I know people are turning bearish on the economy and stocks, especially with the current impasse on the debt ceiling issue. Although I’m bearish on stocks in the short to intermediate term, I’m very bullish long term (5-10 years). Let me briefly explain my thinking.
Everyone likes to think of themselves as an independent thinker who “goes against the herd.” This is nice and all, but when it comes time to make a big contrarian bet, most people freeze under the pressure. I believe hardcore bears are being overly influenced by recent events in the same way that those who were calling for Dow 36,000 at the peak of the internet bubble were deluded by the 25%+ annual gains in stocks. Whenever you approach an extreme in pessimism or optimism, you should take a step back.
What if I told you in 1999 that stocks in 2011 would be trading just about flat in nominal terms, and down in real terms? What if I then told you that people in 2011 were generally bearish on stocks? Wouldn’t the supposed contrarian in you be backing up the truck and buying? If you are nodding your head in agreement, I must ask: Why aren’t you buying?
Epic stock market rallies are preceded by extended periods of consolidation. The Dow first traded at 100 in 1906; it wasn’t until 1942 that 100 was breached for good. The Dow first traded at 1000 in 1966; it wasn’t until 1983 that 1000 was breached for good. The critical level in the current cycle is 10,000, which was breached first in 1999. Since then, we’ve experienced terrorist attacks, wars, a huge recession, and a stock market crash. Some people view these events as signs of the end of the world, but I don’t- this is just a period of consolidation. Believe it or not, stocks are basing for a big move.
Stocks don’t rise uniformly with earnings; in fact, stocks have traded flat while earnings have risen exponentially and vice versa. If I had to hazard a guess, I’d say that earnings will continue to rise while stocks trade flat to down in the short-term. This would bring down P/E ratios without us having to experience a stock market crash. When people are lulled to sleep, that’s when the monster rally in stocks will probably commence.
Money Supply/Velocity of Money
One of my pet peeves is when people are inconsistent and intellectually dishonest with their theories. There are people who rail against the government’s manipulation of economic data, which is fine, but if they happen to be a deflationist, the CPI is shockingly the only metric they don’t believe is manipulated down. How is this not biased analysis? In the same way, how can you agree that money supply is rising along with inflation and call for a 90% stock market crash? And how can you say that confidence is going to collapse but there will be deflation, meaning people will flock to the dollar? It just doesn’t make sense.
The money supply in America has been rising, and this is contributing to inflation. Sooner or later, this newly created money will find its way into stocks, creating the apparent anomaly of rising stocks in an economic downturn. The lag between money supply growth and the stock market means that the stock market is building energy.
M2 Money Supply
Velocity of Money
Stocks won’t truly explode until the velocity of money does. Right now the velocity of money is relatively subdued compared to the boom years of the 90s. This is going to change. When confidence in our government collapses, you will see the velocity of money explode as people attempt to protect their assets. Watch for the bottom in the velocity of money to closely correspond with the bottom in stocks.
I can go into greater detail, but I just want to show that I am not being a heretic by thinking stocks are going to rise. If you want an asset class to be bearish on, choose bonds.Follow