- November 25, 2011
Why This Might be a Bear Trap
by Donald Harder
The similarities between today’s market and 2008 are the same on their face, which should put everyone in defense mode. In fact, 3 out of 4 bear market warning signs have now appeared and the bear threatens to show its ugly face for a third time this tumultuous 21st century. Lest everyone give up all hope, we are here to tell you that this is not your 2008 market, nor is it a typical bear market set up. The differences are nuanced, but they could prove important in the upcoming months for traders and investors alike.
No Economic Slowdown
In 2008 Bear Sterns and Lehman grabbed the headlines as they went belly up and the markets did a belly flop, but when the markets were putting out their initial bear market warning signs in 2007, it was company earnings that had the markets putting in an ugly head and shoulders topping pattern. Back then, the economy was showing signs of slow down and corporate earnings were sliding too.
Today, this is just not true. While earnings and economic growth are running at a relatively slow pace, they are certainly much better than investors give them credit for according to The Street and Seeking Alpha.
Bearish Sentiment
Also unlike 2007-2008, investors, especially retail level investors, are on pins and needles today and bearish sentiment runs through the veins of the nation. Bear markets tend to emerge after times of enthusiasm as retail investors buy into the idea that upside momentum can push prices to much higher levels. Today, it simply takes a quick look at the headlines to understand that people are just plain scared. Scared of a European breakup, scared that more jobs will be lost, scared that the apocalypse that outshines all apocalypses is knocking at the door.
This time may be different, but don’t kid yourself, this is more typical of a wall of worry than it is a market top.
Stock Values
During the emergence of the tech bubble in the 90s, company valuations got lost as stock prices rose based on a ‘this time is different’ mentality amongst investors who found out the hard way that things rarely are ever different. In 2007, share prices were almost as overvalued as they were at the 2000 market top.
Today, the picture is very, very different. Today it’s stock prices that are undervalued compared to earnings, which you can see in the chart below provided by Todd Sullivan:
Fly in the Ointment
A good trader never makes a trade unless he has a hedge or an exit strategy, so here’s our hedge. While the markets may indeed be setting up a bear trap here, Europe may be the fly that spoils the ointment. Until the European credit situation finds a lasting resolution, prices may continue to bleed lower as smart money sells the bounces to reduce risk exposure. If Europe does implode, well then, we probably have some seriously difficult years ahead of us. It’s our best guess they’ll come to a resolution that most can live with. Permabear fantasies of impending apocalypses have seldom, if never played out to the degree they imagine and playing off the ‘this time is different’ rule, we doubt this time will be different either, but it is still a risk until it’s not.
1 Comment
Valuation isn’t the best timing tool, as Buffet showed in ’08 when he bought in the middle of the crash, not the bottom, but interesting nontheless. Thanks!