Saturday, May 23, 2009

The bull market isn't on the way, it's already here

Recoveries creep up on you, pounce and are easily missed. Just look at Goldman Sachs: back on October 10, the day before the investment bank went on the Troubled Asset Relief Program dole, its shares closed at $88.80. At the time, it was considered one of the strongest banks in the sector--but that's a pretty low bar.

Now Goldman shares trade at $142, up more than 60%. Investors who missed this rally can be forgiven for staying away from Goldman stock over the last eight months, given all the uncertainty in the sector, but here's the truth: There's always uncertainty, in good markets and bad.

The stock market is a leading indicator, forecasting events six months to a year in the future, and market players have to stay invested during bad times in order to take advantage of bull runs. The broader market is up 37% since early March, when many believe that the U.S. stock market found its bottom.

In May, strategists at JPMorgan Chase declared that the stock market had bottomed March 9, when the S&P 500 hit a low of 669. These same strategists, Thomas J. Lee, Bhupinder B. Singh and Daniel M. McElligott, predicted in November 2008, while many were talking about the possibilities of a full-blown depression, that the S&P would bottom between out in the range of 670 to 720. They now believe we’re in month two of a bull market, and not, as some would have it, a bull rally in a bear market.

"The four most severe Bear markets saw retracements of the prior bull market of 107% to 114%," says the JPMorgan report. "1974 was the most severe, with a 114% retracement, but is also comparable to the current period, as the 1974 low coincided with breaching a 12-year low. The 2002 bear market, incidentally, retraced 61% of the prior bull market."

So what happens next? History suggests we're likely to test the lows again, or to at least have this rally give way for a little while. "It is entirely possible that a retracement may not happen, as this rally’s 64-plus days is one of the longest historically following a market bottom. But if one does not emerge within the next few weeks, it may be that the 2009 bottom was a "V" bottom, similar to 1942 and 1949."

Calling a bottom is a tricky thing, and many investors have been burned trying to do it. The JPMorgan call might be wrong, and the bears do make some compelling arguments. Meredith Whitney of the Meredith Whitney Advisory Group believes the major banks, including Bank of America ), are going to cut lines of credit in response to the worsening condition of borrower balance sheets and to get ahead of new government regulations that will restrict a bank's ability to unilaterally change credit card rates. With less credit available and unemployment worsening, the American consumer could be left barely afloat, unable lead an economic recovery

JPMorgan suggests a classic recovery strategy for investors: Buy the sectors that will lead the market out, starting with financials, where the mess began, and then moving in on technology and biotech along with consumer discretionary stocks. All of these should benefit as consumer confidence is renewed. Among their top picks are United States Steel

The JPMorgan forecast is right in line with a call made by Legg Mason strategists at the end of last year. Hersh Cohen, chief investment officer of Clearbridge Advisors at Legg looked at "waterfall declines" in the market in 1962, 1974, 1987 and 2002 and concluded that they tend to signal market bottoms or near market bottoms--with the only exceptions occurring in the 1930s. Also, Moody's Economy.com Chief Economist Mark Zandi, who was early in seeing the housing bubble form, concluded that both the markets and the economy found a bottom in March .

One problem for investors is that we'll have continued bad news on the economic front, particularly concerning housing and job losses. The bull's case is that the market has properly accounted for all of those factors, and history suggests remaining invested--because when the news is better, it will be too late.

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