Are the Bears Going Back into Hibernation?

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October 19, 2011 10:48am NASDAQ:QQQ NASDAQ:QQQQ

To say that the past few months were rough on the markets is an understatement… After smooth sailing in the first half of 2011, the markets became dreadful, choppy waters for most investors. Fear was the main driver as financial catastrophe in Europe and America are thought to be triggering a global recession

. Since July, the S&P 500 has been teetering on the edge of collapse, while precious metals and other safe havens such as U.S. treasuries and so-called “defensive” stocks ballooned in value.

S&P 500 vs. GLD - GLD Wins!

Positive Signs From Leading Economic Indicators

Although unemployment doesn’t seem to be improving much, there are some positive signs from a few leading economic indicators:

  • U.S. auto sales – One of the first indicators of whether the economy is going into a recession or rally is auto sales. In early October, it was reported that U.S. auto sales were up 10 percent in September over August. It’s the fastest pace in auto sales since April. Further, U.S. retail sales in September (led by car sales) grew at the fastest pace in seven months.
  • The Purchasing Managers’ Index – PMI measures manufacturing and tends to track the economy fairly well. In October, NAPM reported that the PMI increased for the twenty-sixth consecutive month by one percent from August to September. The Production Index was at 51.2 percent, showing a return to growth after contracting in August for the first time since May of 2009.
  • U.S. housing starts – Housing starts are another leading economic indicator. On Wednesday, the U.S. Census Bureau reported that housing starts were up 15 percent, the highest level in 17 months. On Tuesday, Bloomberg reported that U.S. homebuilders are “less pessimistic” about a recovery in the sector. Homebuilders are still way below the minimum optimistic level of 50, but rising from 14 to 18 is a good start and the highest reading since April 2010.

Other Possible Signs of Recovery

Last week, Louis Basenese of Wall Street Daily outlined plenty of reasons why he’s taking a contrarian stance toward recession fears.

In summary, Louis sees the following reasons why we may be headed for greener pastures:

  • Too many people are bearish – As Warren Buffett once said: “Be fearful when others are greedy, and be greedy when others are fearful.”
  • Insiders are buying personally and executing share buybacks – As Peter Lynch wrote: “Insiders might sell their shares for any number of reasons, but they buy them for only one: They think the stock price is undervalued and will eventually go up.”
  • Stocks are cheap by historical standards – Basenese points out that judging by free cash flow yields, P/E ratios and future P/E ratios, stocks are well below average values. For instance, the average aggregate P/E value for the S&P 500 since 1950 is 18. Right now, it’s hovering 25-percent lower at around 13.5.
  • The market historically rallies after high VIX ratings – According to Bloomberg data, when the VIX Volatility Index rises above 40, the S&P 500 rallies 3.2 percent over the next three months – and 19 percent over the next year.

Safe Havens and Defensive Stocks Expensive

So-called safe havens such as gold and U.S. Treasuries seem to be in bubbles due to the flood out of securities. Further, defensive stocks, such as companies that produce consumer staples, seem to be expensive now, too. And valuations for household goods producers are currently at the highest levels since 2008.

According to Bloomberg, “The last time household-goods producers were this expensive versus the MSCI World, stocks were about to begin an advance in which bank, mining and industrial stocks jumped more than 137 percent, while consumer staples rose 76 percent.”

Investors’ Take

While there are certainly reasons to be bearish considering the world debt woes, stalling growth and high unemployment in the United States, it’s usually darkest just before dawn.

Contrarian investors may be wise to slowly shift from safer defensive plays to more aggressive growth investments. While a recovery doesn’t quite appear imminent, there are some signs things are turning over.

As Traxis Global Equity Macro Fund Manager Barton Biggs told Bloomberg, “I’m inclined to stay where I am, which is moderately, cowardly bullish. The thing that makes me want to hang in there is that the high frequency economic news from the United States has definitely improved. It’s gotten pretty good.”

Good investing,

by Justin Dove, Investment U Research

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