Tuesday, October 10, 2006

When will it be time to be more bearish (again)?

I've had to listen to market bears--their cynicism, conspiracy theories, media hype, and gloom and doom (maybe it is a personality thing)--for almost the whole year, as the Dow drifted from 11,000 towards 10,000.

Now that it is drifting up towards 12,000, the bears are like dried up Sea Monkeys. But when the rain comes, the brine shrimp will be back out in force.

For me, the time to get bearish again is when forward earnings come within 1% of treasury yields. Right now, treasuries are yielding close to 5% while S&P 500 earnings are yielding close to 7%. But, let's say that bonds sell off to yield 6% and large caps rally up such that forward P/E ratios are over 17 (only 15 today); then it might be the right time to start taking some profits and thinking about putting on some shorts.

But the housing contraction will not be so bad. I think that it will only affect 5% of households, while the cynics think it will affect over 20%. Now 25% of homes are owned outright, and more than 95% of mortgage holders have over 20% of their home values in equity, and most folks who rent are lower middle class--the crash will come only to homebuilders (who have inventories), greedy speculators who own more properties than they can finance, and some people who are so addicted to spending that they must immediately cash out any gains in their property valuation. Is that really one out of three or four households across America? No, it's less than one out of ten. And homebuilders are less than 3/10% of the market capitalization of the US.

And the buzz over inflation, yeah sure, the government has revised the CPI calculation so inflation doesn't look so bad as previous formulations would have concluded. But CPI also understates inflation, as is stated here, here, and here.

So, its fine to sell the rallies and buy the dips, but don't be caught short right now; rather, be flat to long. The Dow will be swooning sometime in the not too distant future, but outside of a major news event, it won't be today.

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