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Stock Bull Being Born

Adam Hamilton from Zeal writes here what he believes should be a start of a new cyclical bull market. Funny that he mentions not alot of bulls out there when i still hear people getting in the markets now haha…

With the election of a new President, it was an important week for the financial markets. Whether you were part of the 53% of Americans who voted for Obama or the 47% who voted against him, you’ve got to be thankful this bitter campaign has ended. A peaceful regime change is a great blessing that should not be overlooked.

The very next morning it was back to business as usual for the financial markets. Countless traders collated and analyzed all the information available to them to continue trying to best-position their capital for the future they believe is most probable. And prevailing sentiment was definitely morose. No matter who won on Tuesday, today’s serious market and economic problems were going to linger.

The pessimism and gloom is certainly justified. With the S&P 500’s (SPX) 35.1% year-to-date loss, 2008 is heading for the record books as one of the worst stock-market years ever. This bear has been brutal. In its first year which ended October 9th, the SPX was down 41.9%! This was the largest first-year loss in any bear since the one after the 1929 crash plunged 43.8% during its first year. Things look and feel pretty bleak.

With endless bearish arguments out there, many very logical and plausible, it is easy to surrender to the pessimism and capitulate. But if you are a contrarian, somewhere deep in your brain nagging doubts are gnawing away. If virtually everyone is bearish and pessimistic, and almost everyone is discounting Armageddon, shouldn’t I fight the crowd and be bullish? When better to buy low than when practically no one is brave enough to buy?

While it is very hard to be bullish today, my inner contrarian keeps warning me that today’s excessive pessimism and bearishness isn’t sustainable. Every time I unmute CNBC in my office, 95% of the interviews are bearish and negative. Each time I read financial news, a similar unbalanced negative worldview emerges. The bearish trade is certainly extremely crowded today, highly in vogue.

All these newly-minted weathervane bears are amusing to watch. The right time to be bearish was back in the early 2000s, when everyone insisted on staying bullish. Back in 2001 and 2002 I was making the case for a 17-year secular stock bear based on market history. This meant the stock markets were due to grind sideways for the better part of two decades in a giant trading range. It was a heretical thesis at the time.

While the perma-bulls scoffed back then, they are not today. If you are not familiar with the long cycles in the stock markets, my “Long Valuation Waves 3” essay will quickly get you up to speed. Understanding where we are in these long cycles is the single most important piece of knowledge any long-term investor can possess. While most nave investors are crushed in these secular bears, prudent investors can thrive.

I continued this thread of research over the last 7 years, updating it periodically. By January 2008 it was starting to look like we were entering a cyclical bear (lasting a few years) within this 17-year secular bear. While the SPX was still sojourning in the high 1300s I warned

“So is a new bear looming? It depends on what kind of bear we’re talking about here. There are short-term cyclical bears that last a couple years or so, which tend to cut major stock indexes in half. And there are far worse long-term secular bears, which tend to run for 17 years or so. We may be entering the former but we never left the latter.”

This bear-within-a-bear concept is critical today, especially for contrarians. Cyclical bears within secular bears tend to run for a couple years and cut headline stock indexes in half. While our current cyclical bear has only run for half as long, in terms of depth it has already neared the projected 50% decline. At worst on a closing basis between October 2007 and October 2008, the SPX plunged 45.8%!

Add to this observation the fact that secular bears tend to have giant trading ranges. If a given secular bull (like 1982 to 2000) peaks at an indexed level of 100, after that it should gradually meander back and forth between roughly 100 and 50 for 17 years. The 100-to-50 declines are the 50% cyclical bears within the secular bear. And the 50-to-100 increases are the 100% cyclical bulls within the secular bear.

Well, believe it or not, despite the rampant pessimism today our current secular bear’s trading range suggests we could be nearing the beginning of one of these 100% cyclical bulls. And even if our current cyclical bear persists for another year first, its remaining downside should be modest. Since its first year witnessed such an extreme decline, it is likely too low in its secular trading range to fall much farther.

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