My Conservative Bear Market Low: SPX 1500

Right now I am more confidently bearish than normal, although I do have fear of a rally because until this year, almost every breakdown in the markets was saved. Contra the Pavlovian dip buyers, bears became Pavlovian dip avoiders.

Yet, this time the Fed is going to put its thumb on the bears' side and the market still hasn't priced this in.

Bulls aren't as confidently dip buying this year. What I see from the bulls more and more is "it's priced in." Then comes the next piece of bad news...

Bulls are also talking about fundamentals. Fundamentals are on the side of the bears, 100 percent. There's potentially 70 percent downside on the way if fundamentals take over at the same time fear drives the market.

If bulls are talking about fundamentals, it signals to me the bull case is damaged. Doubt is creeping in. They feel the need to justify their actions. No justification is needed in a bull run! Number go up.

Go back to the top point. Either there's a squeeze or rally soon, or the market is going down. Longer-term, it is going down.

Do not value stocks from the market. Do not value stocks as an asset class based on relative measures (sometimes we do value competitors this way, as one example). Valuation is a bottom-up measure of a firm's cash flows. There is also the impact from other markets such as bonds, commodities and so on. If using the market as a measure, one cannot look at price, sales and book ratios without going far back into the past and finding similar setups. At minimum, use valuation measures that go back to the 1970s.

Bulls and bears alike make the mistake of driving in the rearview mirror. Setups are forward looking. The ultimate rearview driving, why we are in an ultra-bubble with an ultra-bearish future, was caused by the Federal Reserve. Peak stupidity was reached in 2020. It can be crystallized in some variation on this statement, which most bulls made in some form or another: "Based on current interest rates, the stock market is fairly valued." True! It was true. And if you told someone years before that inflation would be under 2 percent and interest rates still at 0 percent, and the Fed still doing QE, they probably would have guessed stocks would be higher. Yet, the question at that point is not to say stocks are fairly valued, but can they stay this high? Can things get better for stocks at zero percent interest, low inflation with the Federal Reserve supporting asset prices?

How bad can things get? Stocks as an asset class never became cheap in the 2008 bear market. The government bailed out banks and the Federal Reserve stepped in with QE. Stocks weren't as expensive in 2008 as 2000 though. The stock market was basically up 0 percent from the 2000 peak to the 2007 peak. It was backfilling that level with higher earnings, inflation was raising the nominal level of asset prices. The stock market is in worse shape now than in 2008. The setup in commodities and tech seems similar to me, with a possible far worse outcome if interest rates or inflation normalize.

Which brings me to the bear who cried bear, John Hussman. He has taken arrows for all the bears by making the valuation case. He was pilloried for getting 2008 wrong and explained why. Many bears such as myself also misidentified prior periods at the start of the bear market and were wrong for the same reason: the internals reversed. All these years, Hussman has been making the valuation case for stocks, not as a case for prices right now, but as the base case. Where will the market go if psychology cracks and valuation matters again?

Being wrong on timing doesn't change the reality of valuation. Stocks are expensive. Ultimately, all assets are valued on their cash flows. No investor buying stocks held in funds such as ARKK from 2018 to 2021 was behaving rationally or intelligently. Note I used the word investor. Traders were correct in going long, but as an investor, you do not overpay for assets. Period. 

If the market wants to be irrational, let it be irrational. If someone is selling a house for three times the price of houses around it, and there's no reason for that price, is it smart to buy that house? As a trader, maybe if you can sell it for four times. And the next guy can sell it for five times. If they ever run out these speculators though, if homebuyers are the only buyers because traders leave, then the price of the home will crater back to that of competing homes.

Anyone who thinks stocks are a buy in May 2022 based on valuation has been desensitized. They are not pricing stocks on fundamentals. They are pricing stocks on psychology. Crazy people were paying 50x for this stock, now it is 30x, so it is cheap! When psychology changes and fundamentals come out as a justification, the bears are in charge because if we price stocks on fundamentals, then we start pricing them for long-term cash flow. That is a very ugly picture for stocks. In this story, the value investor and the bear are on the same side. 

Bears like myself are also looking at issues such as inflation, interest rates, an economy ravaged by ESG and green ideology that has limited energy production. Energy is to the economy as oxygen is to a fire. Starve the economy of energy and recession, depression and collapse will follow. The Western world is run by people intentionally starving the economy. Investors are going along with it thinking they will make money! They are financing their own demise. 

Leaving aside the commodities situation, someone will be buying bonds because the Fed won't be buying. They cannot do QE in the environment created by the ruling class. That means you, dear investor, will be buying more bonds. How much are you willing to pay? Well, I'll tell you what, a lot of people worried about inflation sure like the looks of those inflation-protected I bonds. Three-percent interest on a 10-year bond, no thanks. Ten-percent interest on an inflation-protected bond? Sounds good. Guess which way interest rates are headed as the Fed starts unholding bonds and someone else has to hold them? (Not in the short-term of course...as stocks fall 10, 20, 30-percent the slightly negative real yield on a 10-year treasury bond starts looking mighty good.)

John Hussman lays out the fundamental reasons for bearishness. Go read the whole thing and digest the implications: Repricing a Market Priced for Zero. I once heard you have to say something six times to be sure everyone heard it so: 

Go read the whole thing and digest the implications: Repricing a Market Priced for Zero

Go read the whole thing and digest the implications: Repricing a Market Priced for Zero

Go read the whole thing and digest the implications: Repricing a Market Priced for Zero

Go read the whole thing and digest the implications: Repricing a Market Priced for Zero

Go read the whole thing and digest the implications: Repricing a Market Priced for Zero

I will reproduce one chart. This shows the expected future return on the S&P 500 for various price levels.

Now to the title of my post. From the chart, I think 1500 is a reasonable low target for a bear market. I think March 2020 lows will fall and the next logical stop is that area. I also know that, as in March 2020 and March 2009, stocks can bottom on spike lows. Looking at my chart, long-term support has touches in 1942, 1974 and 1982. The expanding megaphone line that goes near the 2018 low and touches the 2020 low, is around 1575 in March 2026. Right where long-term support would be then.

Going back to Hussman's valuation model. Most bull markets have had double-digit returns off their lows. To get the S&P 500 there in the near-term would require a sub-1000 level. Hence my calling 1500 a conservative target. If inflation is high enough to boost earnings, odds of a higher low rise. If the bear market is more front-loaded, a spectacular bear market, one for the century, could unfold. It seems crazy until you understand that saving the economy in this scenario could involve "permanently" higher inflation and interest rates for the cycle. If inflation is 6-percent and interest rates are 8-percent, then you could simply look at Hussman's model to see that the S&P 500 Index would be around the 1500 area if investors are indifferent between an 8-percent 10-year U.S. Treasury and an 8-percent annualized nominal return on the S&P 500 Index. I am not forecasting 8-percent interest rates (should I though, if I think 1500 is a viable target...), only giving an example of the model. 

The example above brings everything back to something said over the past decade: TINA. There Is No Alternative...to stocks. As soon as there is an alternative, stocks are precariously valued. If the alternatives become more attractive and start diverting capital sway from stocks, a horrendous bear market can emerge after 40 years of hibernation.