Equity Bulls Still in Denial       May  2001 - Issue 9

That's it then! Five aggressive ½% rate cuts by the Fed and the promise of tax reductions have done the job. The bear market in the US is over, with the Nasdaq bottom witnessed on the 4th April 2001, since when it has rallied by a near 40%. Fill your boots with the buying opportunity of a lifetime. Such is the sentiment permeating the financial media and a large proportion of the Money Management industry. Thank god for Uncle Al and George W. Sorry but we do not agree. Whilst life would be grand if excess never had to be worked off, we have to be realists and the financial excesses of the past few years were always likely to have produced a rather large hangover. The initial stages of a bear market, and particularly a 'once in a century' bear market such as is unfolding within the US are very confusing to the majority of investors. Human emotions switch constantly from fear to hope and back to fear as the markets plunge; retrace part of the falls, only then to fall again.

The largest bear market in the US history was punctuated by seven very significant rallies on its way to a final conclusion, as can be seen in the chart above. Even allowing for these the market fell by 90% from its bubble top in 1929 to the 1932 bottom. We are not implying that it is 1929 all over again but merely pointing out that short lived rallies are a part of what define overall bear markets. Volatility defines the bear market, not linear action.

Buy and hold strategists are quick to point out that it is impossible to time the markets, and that you run the risk of missing the large gains usual at the early stages of a new bull market. If this is the case, then why are we paying Fund Managers? It may be difficult to market time, but not impossible.

It has been interesting to analyse record one-day gains. In the case of Nasdaq, nine of the top ten one day percentage gains occurred within the context of the worst bear market in Nasdaq history - the current one!

Looking for further evidence, once again nine of the ten largest single one-day percentage gains in the Dow occurred during the worst Dow bear market in financial history - the one shown above. History is clear in that investors should beware of record one-day percentage gains. They have all happened in what seems to be the worst possible times to have been invested in the markets.

Returning to the present, bear markets do not end with markets valued at over twice their long run average. In the case of the Dow and S&P 500, P/E's of 30x and dividend yields of 1% do not offer value, far from it when looked at in price to book and Q ratio terms. Nasdaq, of course is still in a league of its own with the top 100 companies offering a bargain priced P/E multiple in excess of 100x, even though the market is half its value of a year ago.

The bubble psychology is alive and well in the US, of that there is little doubt. The recent aggressive rate cuts and money printing has created a second bubble within real estate to match that of the equity markets. As in previous secular bear markets; the equity bulls are in denial. No doubt, as in the past, they will remain in dreamland until the ultimate bottom. We will take care not to join them.